Retirement Distribution Planning: Strategies for Lifelong Income

Transcription

1 Retirement Distribution Planning: Strategies for Lifelong Income Jim C. Otar CFP, CMT, M.Eng. Outline Market History and Retirement Planning Time Value of Fluctuations Mathematics of Loss Two Warning Signals Eight Deadly Sins The Zone Strategy Case Studies 2 Standard Retirement Plan Retiring now at age 65 Age of death 95 Start with $1 million Withdrawal $50,000 / year (IWR = 5%) Inflation: 3% per year Growth Rate: 8% per year A 30-year FORECAST! 3 Copyright 2010 Inc. 1

2 Standard Retirement Plan GREAT! I will have sufficient money for retirement AND leave and leave estate 4 Standard Retirement Plan 2% inflation 5 Real Life Retirement Plan Retiring now at age 65 Age of death 95 Start with $1 million Withdrawal $50,000 / year (IWR: 5%) Inflation: 3 % Actual Growth Rate: 8% Actual 6 Copyright 2010 Inc. 2

3 The Reality - Story of Three Generations Using actual market history, let s look at portfolios for three generations. We will not make a forecast (no assumed growth rate and no assumed inflation). We will make an aftcast. Aftcast means looking at historical outcomes as they would have happened in the past. 7 A Look at 110 years of DJIA Grandson retires in ,000 10,000 Grandfather retires in 1929 Son retires in 1966 DJIA 1, Data Source: Dow Jones & Company Retire in DJI, CDNSTRAIL-B Wow! Nice Bull Market! Good Time to Retire! Copyright 2010 Inc. 3

4 Retire in /1/1929 8% Growth 3% Inflation 10 Retire in /1/1930 Equity index: DJIA, historical total return less 2% portfolio and management costs 11 Retire in /1/1931 Equity index: DJIA, historical total return less 2% portfolio and management costs 12 Copyright 2010 Inc. 4

5 Retire in /1/1933 Equity index: DJIA, historical total return less 2% portfolio and management costs 13 Retire in ,000 10, DJIA 1, % 10 Data Source: Dow Jones & Company Retire in Equity index: DJIA, historical total return less 2% portfolio and management costs 15 Copyright 2010 Inc. 5

6 Retire in ,000 10,000 DJIA 1, Retire 1941 Broke 1959 Dead Data Source: Dow Jones & Company Retire in DJI, CDNSTRAIL-B Wow! Nice Bull Market! Good Time to Retire! Retire in /1/1966 8% Growth 3% Inflation 18 Copyright 2010 Inc. 6

7 Retire in /1/1966 1/1/1981 Equity index: DJIA, historical total return less 2% portfolio and management costs 19 Retire in ,000 10, Retire 1981 Broke DJIA 1, Dead 10 Data Source: Dow Jones & Company Retire in ,000 10,000 Wow! Nice Bull Market! Good Time to Retire? DJIA 1, Data Source: Dow Jones & Company Will history repeat itself? Copyright 2010 Inc. 7

8 Retire in /1/2000 8% Growth 3% Inflation 22 Retire in 2000 $3,000,000 $2,500,000 Portfolio Value $2,000,000 $1,500,000 $1,000,000 1/1/2010 $500,000 $ Age Equity index: DJIA, historical total return less 2% portfolio and management costs 23 Retire in 2000 $3,000,000 $2,500,000 Portfolio Value $2,000,000 $1,500,000 $1,000,000 $500,000 1/1/2016 $ Age Equity index: DJIA, historical total return less 2% portfolio and management costs 24 Copyright 2010 Inc. 8

9 The Reality - Story of Three Generations Each retired at age 65 and took out 5% initial withdrawal rate. The grandfather retired in He ran out of money at age 77. The son retired in He ran out of money at age 80. The grandson retired in He will likely run out of money by age Retire in Any Year Since 1900, DJIA 48% failure Equity index: DJIA, historical total return less 2% portfolio and management costs 26 Retire in Any Year Since 1900, S&P500 43% failure Equity index: S&P500, historical total return less 2% portfolio and management costs 27 Copyright 2010 Inc. 9

10 Retire in Any Year Since 1900: Balanced 40/60 S&P500 / FI 38% failure Equity index: S&P500, historical total return less 2% portfolio and management costs. Fixed Income: Historical 6-month CD yield plus 1%. 28 Retire in Any Year Since 1900: 100% Fixed Income 40% failure Fixed Income: Historical 6-month CD yield plus 1%. 29 Market Trends Market Trends are the second most important factor for portfolio longevity, second only to the withdrawal rate 30 Copyright 2010 Inc. 10

11 Secular Market Trends 100,000 10,000 Markets are made up of SECULAR TRENDS DJIA 1, Data Source: Dow Jones & Company Cyclical Market Trends: Building Blocks of Secular Trends 100,000 10,000 DJIA 1,000 CYCLICAL Data Source: Dow Jones & Company The Time Value of Fluctuations TVF is the combined losses in a distribution portfolio due to factors beyond our control. They are the friction losses of a distribution portfolio. If you ignore the TVF then MOST asset value projections in retirement plans will FAIL. 33 Copyright 2010 Inc. 11

12 Secular Trends = The Luck Factor Cyclical Trends Contributors of Time Value of Fluctuations Sequence of Returns Inflation Waves Reverse Dollar Cost Averaging Random Fluctuations 34 Secular Trends: The Luck Factor 100,000 DJIA 10,000 1,000 Luck is the only variable! 100 Portfolio Life, yrs Equity index: 40% DJIA / 60% FI, Initial Withdrawal Rate 6% 35 Inflation 36 Copyright 2010 Inc. 12

13 Inflation Inflation Growth 11.5% 4.3% 4.2% -1.2% 16.4% 4.5% 3.2% -6.3% -31.7% 3.3% 15.9% 6.9% 1.9% 1.7% Sideways 3.2% 5.2% Bull 14.3% 1.8% Bear -31.7% -6.3% Inflation Inflation creates an increased income demand for the remainder of a retiree s life Worst in secular sideways markets, best in secular bull markets. Equities do NOT provide an inflation hedge in secular sideways trends. 38 Reverse Dollar-Cost Averaging Reverse Dollar-Cost Averaging means withdrawing a fixed dollar amount on a periodic basis from your investments. In each bear market, more shares must be sold to provide income; a permanent loss Taking out money from equities or other volatile investments on a periodic basis can reduce the portfolio life by 20%, based on market history. 39 Copyright 2010 Inc. 13

14 Reverse Dollar-Cost Averaging Remedies: In the distribution phase (during retirement), take out the periodic income only from the non-volatile investments money market, cash balance, etc. In the fixed income portion of your portfolio: Keep two year s of income in money market/cash, and keep three years of income in short term bonds. 40 Determinants of Success in Distribution Portfolios Initial Withdrawal Rate 4% 6% 8% Sequence of Returns 21% 21% 28% Inflation 13% 20% 25% Asset Selection 16% 18% 16% Portfolio Costs 21% 16% 14% Asset Allocation 17% 14% 10% Others 12% 11% 7% Equity proxy: S&P Mathematics of Loss The mathematics of loss in a distribution portfolio works entirely different from an accumulation portfolio. 42 Copyright 2010 Inc. 14

15 Accumulation Portfolios If you had paid $10 per share last week and it is now $8, you lost $2. The loss is 20% of the original share price of $10. To break-even, you need to make $2, which is 25% of the current share price of $8. 43 Distribution Portfolios Each time you make a withdrawal after a loss, you create a permanent loss in the portfolio. Subsequently, you need to recover from the initial losses, as well as from these permanent losses. Recovery in a distribution portfolio is a lot harder if not impossible- than in an accumulation portfolio. 44 In a Distribution Portfolio, the Loss is Permanent Retire in 1929: : The best cyclical bullish trend of 20 th century up 300% Equity index: DJIA, historical total return less 2% portfolio and management costs 45 Copyright 2010 Inc. 15

16 In a Distribution Portfolio, the Loss is Permanent Portfolio Value $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 Retire in 2000: The first cyclical bullish trend of 21 st century $500,000 $ Age Equity index: DJIA, historical total return less 2% portfolio and management costs 46 Gain Required to Break Even % Loss Initial Withdrawal Rate 0% 4% 8% % Gain Required over 3 years 10% 11% 26% 41% 20% 25% 42% 60% 30% 43% 63% 86% 50% 100% 132% 169% 47 Probability of Permanent Loss Historically, if there are no withdrawals at all, a balanced portfolio recovered from worst losses in eight years. 40% S&P500, 60% Fixed Income 48 Copyright 2010 Inc. 16

17 Probability of Permanent Loss However, when there is even a smallest periodic withdrawal, a full recovery might never happen. At 3% IWR, historically, there was about 20% chance of never recovering. 40% S&P500, 60% Fixed Income 49 Probability of Permanent Loss At the other extreme, when the IWR is 8%, by the 11 th year, regardless of how strong of a secular bullish market might be prevailing, the probability of a lower portfolio value is 100%. 40% S&P500, 60% Fixed Income 50 Market versus Portfolio Behavior MARKET DOWN Accumulation PORTFOLIO DOWN Distribution PORTFOLIO DOWN SIDEWAYS SIDEWAYS DOWN UP UP SIDEWAYS When the withdrawal rate is over 4%, the chances are, a distribution portfolio will never increase in value during bullish trends. 51 Copyright 2010 Inc. 17

18 Mathematics of Loss - Distribution In the distribution stage: Sequence of Returns is most important. Volatility of Returns is not important. The concept of the long-term does not exist in distribution portfolios, because a longer time horizon has no effect on sequence of returns. One unlucky month at the start of retirement can chop the portfolio life by 10 years. 52 In a Distribution Portfolio, the Loss is Permanent $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 Retire in 2000: you need 27.2% annual growth for the rest of your life! $500,000 $ Age Equity index: DJIA, historical total return less 2% portfolio and management costs 53 In a Distribution Portfolio, the Loss is Permanent $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 Retire in 2000: you need 25.5% annual growth for the rest of your life! $500,000 $ Age Equity index: DJIA, historical total return less 2% portfolio and management costs 54 Copyright 2010 Inc. 18

19 Psychology of Loss The Mathematics of Loss shows how the markets works against your investments. The Psychology of Loss shows how your behavior works against your investments. Combination of both is lethal to the longevity of a retirement portfolio. 55 Buy and Hold: $1000 grows to $157,809 over 1317 months CAR: 4.7% (index only) 56 Miss the Best 39 months (3%): $1000 remains $1,000 CAR: 0% (index only) 57 Copyright 2010 Inc. 19

20 Miss the Worst 39 months (3%): $1000 grows to $88,269,752 CAR: 10.9% (index only) 58 Investment Outcomes Lose a lot $$$ Lose a little $ Make a little $ Make a lot $$ Favorite Topics: Retirement Income Adequacy Reverse Mortgages Renting your home Favorite Topics: Estate Charitable Giving Foundations Wealth Transfer 59 Psychology of Loss DALBAR s study shows that while the S&P 500 has returned 8.35% over a 20 year period ending in 2008, the average equity investor earned just 1.87%. While a market index can have a statistically average return, the average return of investments of an average investor is the bottom decile (unlucky) of that same market index. 60 Copyright 2010 Inc. 20

21 61 Two Warning Signals How do you know when you might be running out of luck? 62 Warning Signal # 1: The PE Ratio 40 16% 35 14% Portfolio Life at 6% IWR % 10% 8% 6% 4% Earnings Yield 5 Portfolio Life Earnings Yield 2% 0 0% Retirement Year 63 Copyright 2010 Inc. 21

22 Warning Signal # 1: The PE Ratio Take the Average Market PE for the last 4 years, then estimate the portfolio life: Portfolio IWR= 4 + (250 / PE) Portfolio IWR= 4 + (360 / PE) 64 Warning Signal # 1: The PE Ratio Check your Luck Factor: When? At the start of retirement Generally, if the market average PE is above 12, it is unlikely that you ll have lifelong income. 65 Warning Signal # 2: Fourth Year Check-up Check your Luck Factor: When? How? On the 4th anniversary of retirement Ask: Do I have now more money or less money in my portfolio compared to four years ago? 66 Copyright 2010 Inc. 22

23 Warning Signal # 2: Fourth Year Check-up $2,000,000 $1,500,000 Portfolio Value $1,000,000 $500,000 $ Years after Retirement 67 Warning Signal # 2: Fourth Year Check-up $2,000,000 $1,500, Portfolio Value $1,000,000 $500,000 $ Years after Retirement 68 Warning Signal # 2: Fourth Year Check-up Initial Withdrawal Rate If Portfolio Value is Higher If Portfolio Value is Lower Probability of Depletion After 20 years 5% 0% 7% 6% 2% 38% 8% 6% 72% 40/60 DJIA/ FI 69 Copyright 2010 Inc. 23

24 Warning Signal # 2: Fourth Year Check-up If a retirement portfolio loses money in the early years and does not recover within 3 or 4 years, then it is highly likely that it will expire before its owner does. Don t lose, give away or donate money in the first 4 years! 70 Warning Signals - Retire in 2000 $3,000,000 $2,500,000 Portfolio Value $2,000,000 $1,500,000 $1,000,000 $500,000 1/1/2016 $ Age Equity index: DJIA, historical total return less 2% portfolio and management costs 71 Warning Signals What do you do when you see a warning signal? Think of Life Annuities! 72 Copyright 2010 Inc. 24

25 8 Deadly Sins Myths Misconceptions Untruths 73 Deadly Sin #1: Take Higher Risk You need to take higher risk for higher returns In distribution portfolios, higher risk means lower return or shorter portfolio Life in 80% - 85% of the time. 74 Medium Risk: 40% S&P500 / 60% FI Equity index: S&P500, historical total return less 2% portfolio and management costs. Fixed Income: Historical 6-month CD yield plus 1%. 75 Copyright 2010 Inc. 25

26 High Risk: 100% S&P500 Equity index: S&P500, historical total return less 2% portfolio and management costs 76 Deadly Sin #2: Average Life Expectancy You are 65 now. Your average life expectancy is 20 years. So, let s design a retirement plan until age 85. Average life expectancy gives the age by which 50% of clients, who are 65 now, are dead. If you don t want half of your clients run out of money, design for age survival rate of 15% or less. Plan for age of death of 95! 77 Deadly Sin #3: Brinson Study Asset allocation contributes to over 90% of the difference in returns. (Brinson Study) Therefore asset allocation will solve my retirement problem! Once the withdrawal rate exceeds 4%, asset allocation has LITTLE effect on the outcome 78 Copyright 2010 Inc. 26

27 Deadly Sin #3: Brinson Study What are the flaws of applying Brinson study to individual accounts? Short data history used - ignores the secular trends, i.e. the luck factor Pension funds are an open system, individual retirement investments are closed ignores RDCA Ignores the inflation effect 79 Brinson Study Time Coverage 100,000 10,000 DJIA 1, % S&P500 43% failure 100% S&P500, 0% Fixed Income, 5% IWR Alpha=1.5% 81 Copyright 2010 Inc. 27

28 70% S&P500, 30% Fixed Income 36% failure 70% S&P500, 30% Fixed Income, 5% IWR Alpha=1.5%, FI: 6-month CD+0.5% 82 40% S&P500, 60% Fixed Income 38% failure 40% S&P500, 60% Fixed Income, 5% IWR Alpha=1.5%, FI: 6-month CD+0.5% 83 20% S&P500, 80% Fixed Income 39% failure 20% S&P500, 80% Fixed Income, 5% IWR Alpha=1.5%, FI: 6-month CD+0.5% 84 Copyright 2010 Inc. 28

29 100% Fixed Income 0% S&P500, 100% Fixed Income, 5% IWR Alpha=1.5%, FI: 6-month CD+0.5% 40% failure 85 Deadly Sin #4: Over-Diversification Diversification prevents losses Diversification has little effect in distribution portfolios if you are unlucky % S&P500, 60% Fixed Income $4,000,000 $3,500,000 $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $ Age 40% S&P500, 60% Fixed Income, 6% IWR 87 Copyright 2010 Inc. 29

30 40% Nikkei225, 60% Fixed Income $4,000,000 $3,500,000 $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $ Age 40% Nikkei225, 60% Fixed Income, 6% IWR 88 40% FTSE, 60% Fixed Income $4,000,000 $3,500,000 $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $ Age 40% FTSE, 60% Fixed Income, 6% IWR 89 40% SP/TSX, 60% Fixed Income $4,000,000 $3,500,000 $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $ Age 40% SP/TSX, 60% Fixed Income, 6% IWR 90 Copyright 2010 Inc. 30

31 Deadly Sin #5 I will take out only the growth of the portfolio What about years with no growth? Where is the money coming from? 91 Deadly Sin #5 Maximum taken: Growth of the Portfolio or $60,000, whichever is smaller 92 Deadly Sin #5 93 Copyright 2010 Inc. 31

32 Deadly Sin #6 I can take out a constant percentage of my portfolio Constant percentage will not provide a constant purchasing power. 94 Deadly Sin #6 Maximum taken: 6% of the Portfolio Value or $60,000, whichever is smaller 95 Deadly Sin #6 96 Copyright 2010 Inc. 32

33 Deadly Sin #7 Higher dividends create a large part of the retirement income In distribution portfolios, dividends do not matter much for unlucky outcomes. 97 Dividends: Retire in % IWR, All equity $2,000,000 Portfolio Value $1,500,000 $1,000,000 $500,000 Historic Dividend 2% Dividend Index only $ Years after Retirement 98 Dividends Withdrawals during retirement diminishes or eliminates the compounding effect of dividends Unless you are lucky, the time value of dividends is not significant. Dividends alone do not turn a failing portfolio into a successful one, except in very few marginal cases. In spite of that, I like dividend paying stocks in a retirement portfolio. 99 Copyright 2010 Inc. 33

34 Deadly Sin #8 Monte Carlo Simulators can accurately forecast the probability of success. Incorrect, Monte Carlo simulators are manmade models based on certain assumptions. Their outcomes are generally too optimistic. 100 Monte Carlo Simulators Monte Carlo simulations assume random fluctuations around an average growth rate 101 Monte Carlo Simulators generate random outcomes around the straight line, ignore trend discontinuities. They cannot simulate the Sequence of Returns Markets are random in the short term Markets are cyclical in the mid term Markets are trending in the long term 102 Copyright 2010 Inc. 34

35 Monte Carlo Simulators Trend Discontinuities Monte Carlo Simulators cannot simulate Sequence of Events In real life, there is a very specific sequence of events. All events are correlated. 104 Sequence of Events in Market Cycles Peak Contraction Expansion Peak Trough Stocks Bonds Interest Inflation 105 Copyright 2010 Inc. 35

36 Luck Factor The Math Of Loss Warning Signals Create a Personal Pension using Guaranteed Income to cover the Basic Expenses 106 Prerequisite for Retirement A retiree needs two things for a happy and fulfilling retirement: Sufficient Emotional Capacity, and Sufficient Financial Capacity 107 Emotional Capacity for Retirement In the context of retirement finance, the emotional capacity refers to how you react to market events. Choices about asset and income allocation, investment types, annuities and many other decisions depend on this emotional capacity. It is a very important aspect of planning. 108 Copyright 2010 Inc. 36

37 Financial Capacity for Retirement If you do not have sufficient financial capacity, no amount of emotional capacity will improve the outcome. You can be as aggressive as you want with your investments, you might be able to take any market downturn in stride, and you might have been very successful in your own business decisions. It does not matter. The emotional capacity always plays second fiddle to financial capacity. 109 Zone Strategy The Zone Strategy measures the financial capacity of the retiree and provides a framework to base your strategy for lifelong income Purpose of Zone Strategy: For your client: Provide lifelong income For you: Manage your business Use your time more efficiently Attract and keep profitable prospects Avoid future problems, litigation 110 Zone Strategy: STEP 1: How much money do you want? WR - Withdrawal Rate STEP 2: How much can the market give you? SWR - Sustainable Withdrawal Rate STEP 3: How much does an annuity pay you? AR - Annuity Rate 111 Copyright 2010 Inc. 37

38 STEP 2: How Much Can the Market Pay? Sustainable Withdrawal Rate (SWR) Retirement Time Horizon SWR 40 years 3.0% 30 years 3.6% 20 years 5.1% 112 STEP 2: How Much Can the Market Pay? Sustainable Withdrawal Rate (SWR) Say, you have $1 million, retiring at age 65, then SWR 3.6% of $1 million is: SWR = $36,000 indexed to inflation for the rest of your life. 113 STEP 3: How Much Does the Insurance Company Pay? Say, you have $1 million, retiring at age 65 You want a guaranteed income: Fully indexed to CPI Jointly for husband and wife Payments to continue for a minimum of 10 years, even if both spouses die next month A 30%-pay cut upon the death of first spouse AR= $49,000 / year 114 Copyright 2010 Inc. 38

39 The Zone Strategy AR: $49,000 SWR: $36,000 INSUFFICIENT WR: $55,000 SUFFICIENT WR: $40,000 0% ABUNDANT WR: $30, Zone Strategy: What is the Primary Risk? Sequence of Returns (time is your enemy) Volatility of Returns (time is your friend) 116 Zone Strategy: Export or Retain Risk? MUST EXPORT RISK CAN RETAIN RISK 117 Copyright 2010 Inc. 39

40 Zone Strategy: Sell Fear or Hope? Sell FEAR (of running out of money) Sell HOPE (of leaving an estate) 118 Zone Strategy: Is it Accumulation or Decumulation? Decumulation Either, depends on luck Accumulation 119 Zone Strategy: Planning Focus Cash Flow Planning Retirement Planning Risk Planning Investment Planning Tax Planning Estate Planning 120 Copyright 2010 Inc. 40

41 Zone Strategy: Decision Zones for Lifelong Income Guaranteed Income Investment Portfolio INSUFFICIENT SUFFICIENT ABUNDANT x 21 x 30 Copyright Inc. 121 Example A: Abundant Savings Couple, each spouse 65, expect to live 30 years. They need $60,000/year, savings $1,700,000 STEP 1: How much do you want? WR = $60,000 STEP 2: Sustainable Withdrawal Rate: From table: SWR = 3.6%, $61,200 STEP 3: Annuity Rate: From annuity quote: AR = $83, Example A: Retirement Savings Gauge AR: $83,300 SWR: $61,200 ABUNDANT WR: $60,000 0% 123 Copyright 2010 Inc. 41

42 Example A: Abundant Savings $8,000,000 Portfolio Value $6,000,000 $4,000,000 $2,000,000 8% Growth $ Age 124 Example A: Abundant Savings Investment Portfolio $8,000,000 $7,000,000 $6,000,000 Portfolio Value $5,000,000 $4,000,000 $3,000,000 $2,000,000 $1,000,000 Lucky Median Unlucky 8% Grow th $ Age 125 Example B: Insufficient Savings Couple, each spouse 65, expect to live 30 years. They need $60,000/year, savings $1,000,000 STEP 1: How much do you want? WR = $60,000 STEP 2: Sustainable Withdrawal Rate: From table: SWR = 3.6%, $36,000 STEP 3: Annuity Rate: From annuity quote: AR = $49, Copyright 2010 Inc. 42

43 Example B: Retirement Savings Gauge AR: $49,000 INSUFFICIENT WR: $60,000 SWR: $36,000 0% 127 Example B: Insufficient Savings $2,000,000 Portfolio Value $1,000,000 8% Growth $ Age 128 Example B: Insufficient Savings Investment Portfolio $2,000,000 $1,800,000 $1,600,000 $1,400,000 Portfolio Value $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 Lucky Median Unlucky 8% Grow th $ Age 82% failure 129 Copyright 2010 Inc. 43

44 Insufficient Savings- Solutions Potential Solutions: Delay retirement age Get a part time job Reduce expenses GUARANTEED INCOME ONLY! 130 Example C: Sufficient Savings Investments + Life Annuity Couple, each spouse 65, expect to live 30 years. They need $55,000/year, savings $1,300,000 STEP 1: How much do you want? WR = $55,000 STEP 2: Sustainable Withdrawal Rate: From table: SWR = 3.6%, $46,800 STEP 3: Annuity Rate: From annuity quote: AR = $63, Example C: Retirement Savings Gauge AR: $63,700 SUFFICIENT WR: $55,000 SWR: $46,800 0% 132 Copyright 2010 Inc. 44

45 Example C: Sufficient Savings $4,000,000 Portfolio Value $3,000,000 $2,000,000 $1,000,000 8% Growth $ Age 133 Example C: Sufficient Savings Investment Portfolio $4,000,000 $3,500,000 $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 Lucky Median Unlucky 8% Grow th $ Age 36% failure 134 Example C: Sufficient Savings + Life Annuity If you choose a Life Annuity: Calculate how much annuity you need using the Perfect Mix formula: %Annuity = (WR SWR) = ($55,000 $46,800) (AR SWR) ($63,700 46,800) = 49% Annuity Required = 49% of $1,300,000 =$637, Copyright 2010 Inc. 45

46 Example C: Sufficient Savings - Perfect Mix of Investments + Life Annuity $4,000,000 $3,500,000 $3,000,000 Portfolio Value $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 Lucky Median Unlucky 8% Grow th $ Age 5% failure 136 Summary The most important decision in retirement planning is not the asset mix, not what stocks or mutual funds to buy, not the choice of small cap/large cap, domestic/foreign, emerging/developing. The most important decision is to figure out if you have the financial capacity to generate retirement income from investments. The dividing line between HOPE and FEAR is 3.6%. 137 & Questions Answers Jim C. Otar jim@retirementoptimizer.com Copyright 2010 Inc. 46

47 Case Study - August 2010: Bob is 65 years of age, just retired. He expects to live until age 95. His portfolio is valued currently at $600,000 in a 80/20 asset mix (equity/fixed income). He needs a total income of $50,000 annually. He receives $15,000/year in government benefits. He also receives $8,000 from a pension (no increase in pay). All figures are in current dollars. Questions: 1. Based on market history, do you think his savings will last until he is 95? 2. What is his optimum asset mix? 3. How can you secure lifelong income for Bob? Would a life annuity help? Would a GMWB help? 4. Would renting his basement can help (needs to spend $20,000 in renovations for a rental income of $9,000 / year? 5. His mortgage-free home is worth $350,000. His current housing expenses are $12,000/ year. If he were to move to a rental, his housing costs would be $26,000. If he does not want to rent out his basement, when would he be forced to sell his home?