<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (Mar. 13, 1998) -- Continuing with Wednesday's column's request for repeated topics, a number of readers have asked me about investing for retirees. Before I begin, I need to stake out my territory. I'm 38 years old, so I can't speak from a retiree's perspective, and my stance is one based solely on long-term likelihoods, not guarantees.

First, I think each investor's goal should be to retire, not at a specific age, but at a point when his or her portfolio is sufficient to sustain indefinite growth. Why risk out-living your assets? My easy rule of thumb is that you can retire anytime your annual spending needs (including everything) represent only 5% of your total portfolio value. In other words, if you want to retire today and spend $60,000 a year, you should have a portfolio of $1.2 million. If you can limit your spending to 5% - 7% of your total portfolio each year, your assets will be able to sustain you indefinitely.

How should you set up the portfolio, though?

Second, I believe even the retired investor should remain fully invested in stocks. If you retire at age 60, what's to say you won't live another three or four decades? You have to keep portfolio growth in mind in order to protect your portfolio against inflation. And rather than settle for a guaranteed rate of return in bonds or CDs (which may barely keep you even with inflation), you're probably better off in stocks with a continuous long-term approach.

Let's look at an example.

If your portfolio is worth $1 million today and you need $50,000 a year to live on (in today's dollars), here's how it could work with a stock portfolio. Since 1961, the S&P 500 Index has returned just under 12% a year. And the basic 10-stock High Yield Dow Approach has returned just better than 15%, with minimal turnover each year.

Let's assume, however, that the entire portfolio turns over every year and we pay 28% taxes on the whole gain. That leaves us an after-tax return of 10.8%. I think this is pretty conservative, but in a calculation like this, I'd rather err on the side of conservatism.

Year one, then, begins with $1 million. The after-tax return equals $108,000. Pull out 5% of that for the next year's spending needs, or $55,400. (Even after one year, our target "salary" is already higher than we anticipated needing. When that happens, your portfolio will grow even faster if you don't have to pull the whole 5% out each year.) The balance after year one, then, is $1,052,600, and you've funded your spending for year two already.

If this pattern continues for 40 years, that is, a 10.8% after-tax return and withdrawing 5% of the year-end total value, your total portfolio value would be close to $8 million and you'd be paying yourself an annual salary of more than $400,000 a year. Of course, most retirees' expenses don't grow at such a rapid pace since for many investors in retirement, the big debt of a home mortgage is already eliminated. So the total portfolio is likely to grow even faster because 5% of the total value each year may turn out to be excessive after a few years -- a problem we all hope to face some day!

The big fear for the retiree, of course, is inflation. For the past 37 years, inflation has averaged a compounded 4.7% per year. But of course, there have been many years where it's gone considerably higher. And those are the years that threaten a retired investor tied to a fixed rate of interest available in bonds.

Even with a very conservative approach like the High Yield 10, the long-term rate of growth keeps you out-stripping inflation, so your cost of living doesn't suffer throughout your retirement. In years, when the market goes down or performs poorly, you've got enough of a cushion built in where your 5% - 7% spending needs don't devastate your long-term portfolio and force you into panic selling at the market lows.

Think of your retirement portfolio as a trust account and assume it needs to support you and yours forever. Figure out what your spending needs are in today's dollars and multiply it by 20. That's your current retirement target.

Then once you do retire, set up a solid and diverse common-stock portfolio and live off of 5% to 7% of the value per year and you should be set for life, even if they discover a longevity pill and you live to 200 years old! Fool on!

Go Cats!

Kentucky 82 - South Carolina St. 67

[Want to be the first Fool on your block to get a copy of Robert Sheard's forthcoming book? Click here to pre-order your copy of The Unemotional Investor.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   -   5/16  46.63 
 IP   -   1/2   51.00 
 MO   -   1/16  43.44 
 EK   -2  3/16  60.63 
 
 
                    Day   Month    Year 
         FOOL-4   -1.31%   0.55%   5.72% 
         DJIA     -0.66%   0.66%   8.78% 
         S&P 500  -0.13%   1.84%  10.12% 
         NASDAQ   +0.43%   0.07%  12.82% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  289 Int'l Pape    43.13     51.00    18.26% 
  12/31/97  291 Union Carb    42.94     46.63     8.59% 
  12/31/97  206 Eastman Ko    60.56     60.63     0.10% 
  12/31/97  276 Philip Mor    45.25     43.44    -4.01% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  289 Int'l Pape 12463.13  14739.00  $2275.88 
  12/31/97  291 Union Carb 12494.81  13567.88  $1073.06 
  12/31/97  206 Eastman Ko 12475.88  12488.75    $12.88 
  12/31/97  276 Philip Mor 12489.00  11988.75  -$500.25 
  
  
                              CASH     $77.19 
                             TOTAL  $52861.57