A Million Dollars Ain’t What It Used To Be

mcmansion ferrariThat’s the provocative message behind a recent article written by Jeff Sommer of the New York Times,  called “For Retirees, a Million-Dollar Illusion,” that was thoughtfully brought to our attention by a client in Minnesota (thank you!).

Jeff’s point is that it takes more than you think to cover your retirement needs, and far too many of us are woefully behind. Compounding the problem, today’s retirees face a unique investment dilemma as bonds – considered the “safe” choice for many retirees – pay too little to live on.

We encourage everyone to take a look at Jeff’s excellent and wide-ranging article.  Here’s some of the points I think are most relevant to clients:

A bond-heavy portfolio isn’t as safe as you once thought.

Says Jeff:

“The conventional financial advice is that the older you get, the more you should put into bonds, which are widely considered safer than stocks. But consider this bleak picture: A typical 65-year-old couple with $1 million in tax-free municipal bonds want to retire. They plan to withdraw 4 percent of their savings a year — a common, rule-of-thumb drawdown. But under current conditions, if they spend that $40,000 a year, adjusted for inflation, there is a 72 percent probability that they will run through their bond portfolio before they die.  Suddenly, that risk-free bond portfolio is looking risky.”

We just got a pointed lesson in bond risk last month, in May, when fears that the Fed will eventually “taper back” bond purchases caused a big pullback in bond prices across the board, wiping out months of income and pushing almost all fixed-income category returns into negative territory.

Even conservative retirees need a decent rate of return.

Another problem with an all-bond or bond-heavy portfolio is that it can’t generate high enough rates of return.

And rates of return do matter for most clients, unless they have so much money they will never risk blowing through their portfolio. (And yes, we do have some lucky clients in that category, although it’s more a function of their spending too little as opposed to having too much).

Writes Jeff:

” ….for savers, low rates have been a trial. The fundamental problem is that benchmark Treasury yields have been well below 4 percent since early in the financial crisis. That creates brutal math: if your portfolio’s income is below 4 percent, you can’t withdraw 4 percent annually, and add inflation adjustments, without depleting that portfolio over time.”

As explained by Maria A. Bruno, senior investment analyst at Vanguard, in the same article, “If you’re invested only in bonds and you’re withdrawing 4 percent, plus inflation, your portfolio will decline.  That’s why we recommend that most people hold some equities.”

Toward a more nuanced view of asset allocation

Remember that old rule of thumb about holding stocks equal to 100 minus your age?  That’s way out of date for most retirees, in our opinion. Those nearing and in retirement need an investment strategy that keeps enough in stocks to provide continued growth. That’s especially true today, given the problematic outlook for bonds as rates head upward. Our typical client targets between 40% and 60% in stocks in retirement. The low-end of 40% is for people who are more risk-averse and the higher-end of 60% is for those less frazzled by the market’s ups-and-downs.

 Not saving enough? You still have options.

Jeff interviews Alicia Munnell, director of the Center for Retirement Research at Boston College, who views Social Security benefits as “absolutely crucial, even for people with $1 million.”  But Munnell also reminds people that if they haven’t saved enough, there are still other options to salvage their retirement, including “saving more, spending less, (and) working longer.”  (She also mentions tapping home equity to pay ongoing expenses, but for me that’s an invitation to big trouble).  Working longer and delaying Social Security past full retirement age generates an impressive 8% hike in benefits per year … not shabby in an era of 2% Treasury returns.

About Mari Adam

Mari Adam, Certified Financial Planner™ and President of Adam Financial Associates Inc, has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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