It’s widely accepted that a new retiree can safely withdraw 4% of their savings, a 4% drawdown in the first year of retirement and adjust this amount for inflation in subsequent years. Analyses of historical US  return data has shown that this drawdown rate is safe in the sense that the strategy will not lead the retiree to exhaust all of his or her remaining assets for at least 30 years. How safe should you feel about this rule in the years ahead?

According to this study, below even a 4% retirement drawdown rate is too aggressive when it is based on international market returns -
http://www.advisorperspectives.com/newsletters11/An_International_Perspective_on_Safe_Withdrawal_Rates.php

The 4% drawdown rule is based on US financial market returns since 1926, a time period which may have been a "particularly fortuitous" one for the United States. The fear is that using this time period will produce dangerously overinflated retirement drawdown rates if asset returns fail to be so strong in the future. Over the time period mentioned, the US consistently enjoyed among the world's highest inflation-adjusted returns and lowest volatilities for stocks, bonds, bills and inflation.

From an international perspective, a 4% drawdown rate has been problematic. According to the same study as above:

The calculated safe withdrawal rate exceeds 4% in only three of the other 16 countries: Canada, Sweden, and Denmark. As for other countries, the most unfortunate retiree of all was a Japanese person retiring in 1940, whose maximum SWR (safe withdrawal rate) was a miserably low 0.47% as high inflation and low real returns plagued Japan during and after the war. Six countries experienced withdrawal rates below 3%: Spain, Italy, Belgium, France, Germany, and Japan. In Italy, the 4% rule failed 62.5% of the time, and in Japan, such high withdrawals were sustainable for only three years in the worst-case scenario.

Should Americans expect or at least prepare for lower asset returns in the future, such as those that many other countries have experienced?   We can hope that asset returns in this century will continue to be strong supporting necessary drawdown rates, but such assumptions may prove to be too optimistic for current times.

Choosing an investment adviser may be one of the biggest decisions you make regarding your long-term wealth.  If she makes bad financial decisions, funds you worked years to accumulate could be quickly depleted. Even if she makes good financial decisions you may still lose money and suffer sleepless nights wondering if she handled your funds in the best way possible. With so much riding on how your money is invested, how should you go about choosing an investment adviser to trust?

There are too many investment advisers charging high advising fees for mediocre money management. Even worse, (yes, your nightmares may be valid) many of these individuals may know little more than you when it comes to building long-term wealth for retirement or preserving wealth in retirement.

Below is a list of key questions to ask a prospective investment adviser.  In upcoming posts, We will provide you insights for evaluating the answers a candidate investment adviser provides, helping you avoid the results of potential bad financial decisions.

5 key questions to ask a potential investment adviser:

·       What is your approach to building a portfolio?

What type of products do you use to build a portfolio? Does the potential adviser use insurance, asset allocation or both? Does she use ETFs, stocks, mutual funds, futures, options etc…?

·       How does the investment adviser’s approach account for your goals and tolerance for risk?

     Your investment adviser must clearly understand your goals and risk tolerance. It is critical that you arrive at a portfolio with the right amount of risk.

·       Do you believe in active management or passive management?

Active management is an attempt to outperform the market, typically by choosing a collection of stocks that are believed to outperform the overall market, versus just buying index funds.

·       What actions will you take when the market is undergoing extreme events?

Does the investment adviser react to the latest news or is she more of a let-it-ride type?  What’s the reason for her answer? What did she do as the events of 2008 and 2009 unfolded? How about the more recent European debt crisis?

·       Can you explain to me the advising fees that you charge and also the fees for the products that will be used?

Make sure that you clearly understand how and when you will be charged. Focus not only on your adviser’s fees but also on the product fees. Based on your wealth, how much is this in terms of actual dollars and in percent terms? Make no mistake paying excessively high fees is a really bad financial decision.

In upcoming posts we will expound upon the significance of these questions and what your candidate adviser’s answers actually reveal.  

How likely it is that your desired level retirement spending could result in a depletion of savings and financial ruin during retirement?

 
What is the number one financial fear for investors approaching retirement? It is not health care or inflation or nursing home costs. The number one fear is running out of money. And with good reason. With defined pension plans disappearing, individuals living longer, and investment markets becoming more volatile, it is increasingly up to each individual to manage a complex investment plan and an extended period drawing down savings during retirement. It is impossible to predict how long you will live and how well markets will perform, but it is extremely helpful to understand how much you might need to save and spend under different scenarios.

 Free online tools make it simple and easy to experiment with different plans. For example using the free Portfolio Research Retirement Planner you can see how long your savings is predicted to last based on different savings levels, drawdown levels, retirement dates, and risk-adjusted investment return projections.

 Let’s say your current situation is as follows:
-$50,000 in invest-able savings
-50 years old
-plan to contribute $10K to retirement portfolio until retirement
-plan to retire at age 62

We will assume you invest in a medium-risk return portfolio until retirement and a low-risk portfolio after retirement, and 2% inflation. How much can you withdraw from your nest egg without running out of money? In this case, trying to live on a modest $25,000 per year from your savings appears precarious, with a 50% expected probability your portfolio will be depleted by around the age of 72.

 However if your plan is to work until 67 your savings have a 50% likelihood to last until the age of 82. Then if you also increase the risk level of your portfolio prior to retirement (essentially investing in more stocks and other higher risk, higher return assets) your nest egg has 50% probability to last until you are 84; and if markets perform well the portfolio will not run out until after the age of 100. But if markets perform poorly it will be depleted by around the time you are 75.

 The scenarios above of course are quite simple and merely designed to give you a sense of the significant impact adjusting variables can have on your lifestyle for years to come. The order of withdrawal amounts and the timing of market fluctuations can have a dramatic impact on these scenarios. Experimenting with different scenarios can help you with saving and spending goals and selecting the level of investment risk you are willing to take.

 This August 22nd Barron's cover article:

Core /Satellite Investing refers to a model for structuring an individual's investment portfolio between

(1) an efficient, diversified, longer-term portfolio (the core), and 

(2) opportunistic, usually shorter-term investments (satellites). 

The core satellite framework balances the individual's need for a risk-controlled, disciplined, investment with the individual's desire to exploit perceived market opportunities and outperform the markets. 

The core portfolio should be composed of broad asset classes - equities, bonds, cash, commodities, TIPS and REITs - ideally in the form of low-cost index funds or ETFs.  The percentage allocated to the different assets is driven by the investor’s risk-return criteria, while emphasizing a diversified approach. As the core portfolio is invested in passive investment vehicles it seeks market-like returns within asset classes. This may not sound like a particularly ambitious or impressive goal, but matching the returns of the market as a whole is difficult due to the pitfalls of "behavioral finance".Human nature works against investors causing them to trade at the wrong time - usually buying at market peaks and selling at market bottoms. By segregating and maintaining a core portfolio of assets that are rebalanced based on pre-determined, objective factors like fixed weights or a consistent dynamic strategy, investors can more easily adhere to a disciplined, long-term retirement plan. .A final important consideration in the core portfolio is costs. With the plethora of low cost ETFs and index funds that can be used to cheaply build efficient asset allocations it’s not worth paying others to seek alpha in the core portfolio.

The satellite investments, unlike the core portfolio, seek "alpha" or market out-performance. A satellite investment can be any investment that satisfies an individual's whim - Apple stock, silver mining ETFs, contemporary art, bank certificate of deposits, whatever. For most investors the core portfolio provides their primary retirement savings while the satellites provide the means to speculate, pursue financial dreams or address immediate cash concerns. Satellites should be subordinate to the core and pursued only after the core portfolio is adequately funded.

 In the diagram below, the core portfolio is depicted as the central element with satellite objectives orbiting around it:

How much of an individual investor's wealth should be invested in their core portfolio versus satellite investments?

The allocation between core and satellite portfolios can vary based on the investor's age, risk tolerance, their overall wealth relative to their financial needs and their desire to actively manage and trade investments. In the simplified case of an investor with $500,000 in investable assets and a retirement timeframe of 25 years, an advisor might recommend 65-80% of funds be allocated to the core portfolio with at least some of the satellitefunds apportioned to cash equivalents.

What should be the composition of the core portfolio?

Financial professionals will offer various preferences for core asset classes. An example of small cap, mid-cap, large cap equities, emerging market funds, global and domestic bonds, REITs, commodities and TIPS can provide a diversified mix that can be used to mitigate the risks of inflation, deflation, equity bear markets, credit defaults and general market volatility that investors will face in broad market cycles.