<FOOLISH FOUR PORTFOLIO>

Retirement Planning, Part 5
How much can you take out?

by Ann Coleman (TMF [email protected])

Alexandria, VA (July 9, 1999) -- We're going to fast forward a bit here. Imagine today is your last day at the old 9-to-5 grind. You've worked hard, saved hard, and invested Foolishly. You've made your plans and tomorrow you become a financially independent person. It's a good feeling.

Part of your planning involved projecting how much income you would need. We've talked about that in the earlier parts of this series (see the archives for Parts 1-4). How much you take out each year relates to how much you need to have in your retirement account, which relates to how much you need to save each year and how those savings are invested. At the same time, how much you CAN save each year and how you invest it relates to how much you will have in your account, which relates to how much you can safely withdraw each year.

Still with me?

The point is that all of these numbers are interrelated. If you want a higher income in retirement, you need to have a higher starting account value, which means you will need to save more or get a higher return on your investments. It won't just happen. The Foolish Four is a pretty good bet for higher-than-market returns, by the way.

We started this series out by suggesting you define the kind of income you felt you would need for your retirement in today's dollars. Then we discussed how to adjust that for inflation. Then I suggested that you multiply that by 20 to get a portfolio goal.

Today, let's talk about one possible withdrawal plan. The withdrawal plan I am going to suggest does not involve a declining balance. As I have suggested earlier, the idea of planning to have your money last X years really scares me. I intend to live X + 10 years, myself. Short of buying an annuity and resigning myself to a really low rate of return, I can't see any way to assure that I won't run out of money other than what I'm about to describe.

Here's the plan. Invest your funds in the Foolish Four. Withdraw 5% of your balance the first year. The next year, withdraw the same amount plus 2% (your cost of living increase). The next year withdraw, the same amount as in year two plus 2%. The next year, stop and reevaluate. Is your balance significantly above where you started? OK, then you can increase your withdrawal to 5% of the balance, and the next year you can increase it by 2% (that's 2% of your withdrawal, not 2% of the principal) and so on. If your balance is not at least 10% over your starting amount, then stick with the original plan.

You're wondering why I am saying 5%, when the Foolish Four has returned close to 20% over the past 38 years, right?

I can explain it in one word: 1966. In 1966 the Foolish Four lost 23%. And in 1990, the strategy lost 18%. (I guess that's two words.)

A long-term average is an AVERAGE. It's not a guarantee. What that average conceals is a great deal of variety. And if you start your retirement at the wrong time, that variety can be devastating. One of the less well-known attributes of percentages is that a loss is much bigger than a gain.

OK, that takes some explanation. Imagine a portfolio that takes a 20% loss in one year. It takes a 25% gain the next year just to get you back to where you started. Lose 50%? You need a 100% gain to get back to where you were. Try it: a $100,000 portfolio takes a 50% loss. That puts it at $50,000, right? That $50,000 has to double (a 100% gain) just to get you back where you started. A 20% loss needs a 25% gain to balance it. A 25% loss takes a 33.3% increase. A 33.3% loss needs a 50% increase.

I'm not trying to scare anyone, here. Really. But when you are planning how much you can take out of your portfolio in retirement, especially for the first several years, a loss can be catastrophic if you are withdrawing at too high a rate.

Since we can't predict the short-term movements of the market, the only thing that makes sense to me is a withdrawal plan that plans for disaster while letting you take advantage of the good years. That's what this plan does.

Monday, we will talk about this some more, and I will make a spreadsheet available that will let you play with the numbers yourself.

By the way, this plan is not cast in concrete. The point of our discussion of retirement planning is not for me to hand down a plan graven in stone but to get you thinking about some options that may not have been offered by traditional retirement planning services. Those options may or may not be right for you -- but I hope that thinking about them will stimulate you to think a bit outside the typical retirement planning box.

Fool on and prosper!

Today's Stock Lists | 1999 Dow Returns

07/09/99 Close

Stock Change Last -------------------- CAT --- 61.19 JPM - 15/16 140.25 MMM -1 3/16 89.56 IP - 3/16 51.75

Day Month Year History FOOL-4 -0.56% 1.88% 28.13% 30.03% DJIA +0.60% 2.03% 22.70% 22.22% S&P 500 +0.64% 2.22% 14.74% 15.02% NASDAQ +0.77% 4.00% 27.38% 29.13% Rec'd # Security In At Now Change 12/24/98 24 Caterpillar 43.08 61.19 42.03% 12/24/98 9 JP Morgan 105.51 140.25 32.93% 12/24/98 14 3M 73.57 89.56 21.74% 12/24/98 22 Int'l Paper 43.55 51.75 18.83% Rec'd # Security In At Value Change 12/24/98 24 Caterpillar 1034.00 1468.50 $434.50 12/24/98 9 JP Morgan 949.62 1262.25 $312.63 12/24/98 14 3M 1030.00 1253.88 $223.88 12/24/98 22 Int'l Paper 958.12 1138.50 $180.38 Dividends Received $49.99 Cash $28.26 TOTAL $5201.38