<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (April 1, 1998) -- In the past I've written frequently that a retired investor should consider remaining 100% invested in common stocks, rather than settling for the Conventional Wisdom of parking money in fixed income investments. I've argued that if you're able to limit your withdrawals to 5% of your total portfolio value when you retire, you have enough of a cushion to ride out even the worst of bear markets and still remain in stocks.

For this, I've been called irresponsible and worse, so let me support my case with an example using real market history.

Let's assume Tim retired at the end of 1972 with $1,000,000 dollars. (The actual number chosen is irrelevant as long as the correct ratio between withdrawals and total portfolio value is used.) Tim has calculated that he can withdraw $50,000, pay the taxes due, and live on the rest for a full year, so using my Rule of Twenty, he knows his $1,000,000 portfolio will support his retirement. (The Rule of Twenty simply says to multiply the salary you need to live on times twenty to see if you have enough saved to retire.)

But market historians can see what's coming. Tim retired right as the market plunged into the worst bear since the Great Depression. In 1973, the Standard & Poor's 500 lost 14.66%, followed by an additional loss of 26.47% in 1974. In two short years, the major market index shed nearly 40% of its value. Impossible for a retiree fully invested in stocks to survive such a blow, the skeptics declare. I say they're dead wrong. Let's look.

First the assumptions. Tim begins 1973 with $1 million invested in an S&P 500 Index fund. At the beginning of the year he pulls out 5% of the portfolio for 1973 living expenses. Each year after 1973, he raises that salary by 4% to keep pace with inflation, even if that means his annual withdrawal exceeds 5%.

In 1973, then, Tim plunks $50,000 into a money market fund for the year's needs and leaves the remaining $950,000 in his index fund. After the year's loss of 14.66%, he still has $810,730.

At the beginning of 1974, Tim withdraws $52,000 for his annual spending needs ($50,000 times 104%) and leaves the remaining $758,730 in the index, only to have it lose another 26.47%. He ends the bear market with only $557,894 of his original $1 million.

But the bills must still be paid, and he withdraws another $54,080 for 1975, leaves the rest invested and watches his portfolio begin the slow recovery, ending the year with $691,233.

Gradually, Tim's portfolio recovers to its original $1,000,000. In fact, it takes until 1985 for it to do so. But in each and every year from 1973 to 1985, Tim's been able to pull out his annual spending needs with growth for inflation at 4% a year. He hasn't had to panic out of the market simply because his timing was as bad as one can imagine, retiring right at the beginning of a two-year bear market. He hasn't had to eat cat food; he paid himself exactly what he intended to pay himself all along.

Even more importantly, at the low point for the market, after his portfolio had shed over 40% (including his salary), the most he ever had to pull out of his portfolio for spending needs in one year was still just 9.7% of his total portfolio value heading into 1975.

How does Tim's portfolio look today? After 25 years of retirement, Tim is still increasing his salary, even though he has nothing much to spend it on. He paid himself $128,165 in 1997 and ended the year with a total portfolio value of nearly $2.8 million. In other words, even with colossal bad luck upon retirement, and even choosing a conservative and simple strategy like an index fund, Tim has been able to live perfectly comfortably off of his portfolio growth.

Just think if he had invested Foolishly in stocks like the Dow Approach, which actually recorded a gain in the bear market of 1973 and 1974 instead of losing 38%.

I don't think it's irresponsible at all to advise retired investors to consider staying in the stock market. In fact, with the tax-deferred and tax-free accounts available today to save for retirement, it's even easier to do so. As long as the starting ratio of withdrawals to the total value of the portfolio is correct (no more than 5% to 7% to start), even the worst bear market since the Great Depression wouldn't have derailed such a plan. Don't let emotions get in the way of the numerical principles involved. Fool on and retire well!

Current Dow Order | 1998 Dow Returns

[Robert Sheard is the author of the forthcoming book, The Unemotional Investor, due out from Simon & Schuster on May 12. To pre-order your copy, please visit Amazon.com, where it's available at a discounted price.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   +1  1/2   51.63 
 IP   +1  3/4   48.56 
 MO   -1  3/4   39.94 
 EK   +1        65.88 
 
 
                    Day   Month    Year 
         FOOL-4   +1.25%   1.25%   8.13% 
         DJIA     +0.78%   0.78%  12.14% 
         S&P 500  +0.58%   0.58%  14.19% 
         NASDAQ   +0.65%   0.65%  17.66% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  291 Union Carb    42.94     51.63    20.23% 
  12/31/97  289 Int'l Pape    43.13     48.56    12.61% 
  12/31/97  206 Eastman Ko    60.56     65.88     8.77% 
  12/31/97  276 Philip Mor    45.25     39.94   -11.74% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  291 Union Carb 12494.81  15022.88  $2528.06 
  12/31/97  289 Int'l Pape 12463.13  14034.56  $1571.44 
  12/31/97  206 Eastman Ko 12475.88  13570.25  $1094.38 
  12/31/97  276 Philip Mor 12489.00  11022.75 -$1466.25 
  
  
                              CASH    $415.96 
                             TOTAL  $54066.40