<FOOLISH FOUR PORTFOLIO>

Retirement Planning, Part 4
The accumulation stage

by Ann Coleman (TMF [email protected])

Alexandria, VA (July 8, 1999) -- Wow, I sure stirred up a hornet's nest of activity! Retirement planning is apparently a very emotional and hot issue. Thanks to all of you who wrote last weekend, I've had a lot to think about. Even though I've been preaching about the absurdity of "one size fits all" planning, I still didn't realize just how much diversity of need, goals, lifestyle, and opinion was out there.

The thing that surprised me most was how many of you expressed dissatisfaction with conservative retirement planning. The idea of leaving a large estate was definitely unappealing to some folks. I got the impression that a number of people were hoping to spend their last twenty on a final cab to the hospital. The idea of a retirement plan that would maximize spending in one's golden years and minimize what was left had never occurred to me. But it sure seems to be a popular idea.

I'm just not sure it is practical. Of course, it can be done. Any annuity company will gladly show you how. Just don't expect much in the way of annual income.

My purpose in opening this Pandora's box was not to cover all aspects of retirement planning but to encourage everyone to think about planning for a retirement based not on general rules of thumb, but on your own needs and plans. I also intend to demonstrate one way that the right investment strategy can really alter your expectations.

So for the moment, let's focus on just one scenario. This is not a live-it-up-and-die-broke scenario, because I've just never found that appealing enough to investigate. On the other hand, it doesn't call for washing your dishes in cold water and going to bed at sundown to save on the electric bill, either.

I mentioned $50,000 a year as a theoretical retirement income that we could use for demonstration purposes. That's $50,000 in today's dollars, so let's adjust it for inflation assuming 15 years to retirement and an annual inflation rate of 2%. (Adjust to suit your own assumptions.) To adjust for an inflation rate of 2% over the next 15 years, multiply by 1.02 raised to the 15th power (1.3459) or simply multiply 50,000*1.02*1.02*1.02 for a total of 15 times. The exact answer is $67,293.42, but let's round it to $68,000. Precision is silly for projections like this.

OK, if you were to retire in 15 years and wanted to have the equivalent of $50,000 in 1999 spending power in your first year, you would need an annual income of around $68,000. (By the way, that income will actually go a bit further than you might expect if it is coming from your investments. You will be paying income taxes but not Social Security or Medicare. That will add about 7.5% to your spending power.)

What kind of portfolio will you need if you intend to generate that much income from it? Figure 20 times your starting annual withdrawal rate. That's a $1,360,000 nest egg. Why 20? Five percent is one-twentieth. I'm figuring on a starting withdrawal rate of 5% of your principal the first year. Those who hate the idea of leaving a sizable estate will find this figure much too low. And it is low, but there is a very good reason why it is so low. We will have to get into the payout plan tomorrow, though. Today let's just see what it will take to hit that goal.

That's where the Foolish Four comes in. (You knew that was coming, didn't you?)

Over the last 38 years, the Foolish Four has returned a compounded average annual return of 19.6% vs. the Standard & Poor's 500 Index's annual return of 12.3%. The return has been higher in recent years, but using a longer term average lets us project more conservatively. No one is going to be disappointed if they end up with more money, are they?

At the Foolish Four's rate of return you would need a portfolio of $90,000 right now to reach your goal of $1,360,000 in 15 years with no additional contributions. That's assuming that the entire $90,000 is in a tax-deferred retirement account, of course. That's pretty amazing growth. But here's the interesting part: Using the historical return for the S&P, you would need $240,000 right now to reach your goal in 15 years.

Look at it another way: A Roth IRA started today by a 25 year old with $2,000 down and annual contributions of $2000 per year will grow to just over one million dollars in 35 years at 12.3% compounded annually. At the Foolish Four's 19.6% compounded annual return, it will grow to over $6 million.

Market returns are great. Market returns beat most actively managed mutual funds. But there is a better way.

Fool on and prosper!

Today's Stock Lists | 1999 Dow Returns

07/08/99 Close

Stock Change Last -------------------- CAT - 15/16 61.19 JPM -4 13/16 141.19 MMM + 3/8 90.75 IP + 1/8 51.94

Day Month Year History FOOL-4 -1.09% 2.45% 28.85% 30.76% DJIA -0.54% 1.42% 21.97% 21.49% S&P 500 -0.10% 1.58% 14.02% 14.29% NASDAQ +1.05% 3.21% 26.41% 28.15% Rec'd # Security In At Now Change 12/24/98 24 Caterpilla 43.08 61.19 42.03% 12/24/98 9 JP Morgan 105.51 141.19 33.81% 12/24/98 14 3M 73.57 90.75 23.35% 12/24/98 22 Int'l Pape 43.55 51.94 19.26% Rec'd # Security In At Value Change 12/24/98 24 Caterpilla 1034.00 1468.50 $434.50 12/24/98 9 JP Morgan 949.62 1270.69 $321.07 12/24/98 14 3M 1030.00 1270.50 $240.50 12/24/98 22 Int'l Pape 958.12 1142.63 $184.51 Dividends Received $49.99 Cash $28.26 TOTAL $5230.56