How Boomers Can Get Along with Their Investments

In midcareer, people need to get along at work, and in retirement people must get along with their investments. At work in middle life, and with investments in retirement, getting along includes people, but it also involves the circumstances, tasks, and procedures in each setting.

Retirees can manage their own investments as they managed their work, but to do so, they should grow familiar with their assets, understand asset allocation and rebalancing, and keep a steady discipline concerning withdrawals.

One good way to gain confidence with managing a retirement portfolio is to work through a model program year-by-year.

Alice’s Model

The previous post showed that a portfolio of diversified Vanguard mutual funds, when subject to constant withdrawals equal to 4% of the initial portfolio value, performed well over the past 11-year period. The investments need not be with Vanguard. Other companies also offer low-cost index funds. The portfolio ended 2011 with 28% more value than at the beginning of retirement in 2000. In today’s post, a retiree, Alice, will work with this portfolio year-by-year, in effect, getting acquainted with her investments by taking charge.

Alice started retirement with the asset allocation used in the previous post:

These mutual funds represent what is often called a passive approach to investing, in which investors aim to mimic the various markets, not beat them. An index fund contains stocks representative of one or another broad market index, and the fund succeeds when its returns almost equal the index. Research has shown, conclusively in my mind, that a passive approach is best for most investors, but especially for retirees with modest portfolios who need to keep costs low and returns as high as reasonably possible.

Year-by-Year

Alice’s story begins when she retires at the end of 2000 and has $300,000 in her portfolio. During her last year of work, Alice saw the Internet bubble burst and stock markets begin to drop. Softening the effect of those declines, bonds and REITs were up during that year.

Alice started 2001 cautiously, living on a pension, Social Security, and an extra payment from work for accumulated leave. By the end of the year both domestic and international stocks were down again (losing 11% and 20%, respectively). Her bond and REIT funds increased for the year (8% and 12%), but overall, her portfolio dropped 1.3% to $296,130. At the end of 2001, she withdrew the planned $12,000 or 4% of her initial portfolio, giving her $1,000 per month of additional income during 2002.

Domestic stocks declined even more sharply in 2002, Alice’s second year of retirement. Her domestic stock fund was down to $49, 410, a 21%  drop for the year, and her international fund declined 15% to $50,670. Again, bonds and REITs increased, but overall, her portfolio dropped 3.7% to $273,610.

Alice worried about two consecutive years of stock declines because she knew she might need money for three decades or more. She decided to cut her withdrawal in half at the end of the second year, taking out $6,000 instead of $12,000. She rebalanced her portfolio again, keeping the same asset allocation.

In the third year, 2003, all of her investments increased in value, and she ended the year with $326,660. Feeling more confident about the economy, Alice withdrew $12,000, leaving $314,660 invested for the next year.

The following four years, 2004 through 2007, were also good years. At the end of 2006 Alice decided to increase her withdrawal to $13,200, giving her an additional $100 per month for living. At the end of 2007 she again withdrew the larger amount, despite the growing clouds over real estate investments. Her REIT account lost 16.46% in 2007, and the mortgage crisis was developing rapidly. She started 2008 with $407,960.

In 2008, the bottom fell out of most of Alice’s investments. Only bonds increased, registering a modest 5% gain. Overall, her portfolio dropped 20.43%, leaving $324,630 before any withdrawal. She had lost most of her previous gains. The sharp drop scared Alice, and she decided to cut her withdrawal to $10,000, intending to cut it more if her investments continued to fall.

In 2009, her portfolio rebounded by about the same percentage as the previous year’s decline, but working from a lower base, she ended the year with $379,820 before a withdrawal. She decided to return to her $12,000 withdrawal, giving a value at the beginning of 2010 of $367,820.

The next two years were positive, though in 2011 her portfolio growth was very small (1.59%). She continued withdrawals of $12,000 at the end of 2010 and 2011, and the final portfolio value was $397,370, or 32.5% ahead of her beginning value of $300,000.

Simplicity Wins

Alice was 65 years when she retired, and she was 76 at the end of 2011. She feels confident that with continued prudence and reasonable luck, her investments will last the rest of her life and produce a modest estate for relatives and charity. Of course, she knows nothing is certain.

The model retirement experience outlined here worked well because, first, it is based on advice—diversify, rebalance, and be prudent about withdrawals—tested by many objective analyses of long-term investment performance. Second, the model was implemented with a set of low-cost, market mimicking investments—index funds. These investments enable people to keep their costs low and harness almost all of the gross investment return for their own use. That is an important consideration for investors, like Alice, with modest retirement portfolios.

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This post is one of a series on investment and finance. For new readers, or for readers who want to review other posts, navigate to the home page of the blog, then look to the right-hand column. There you will find a list of Categories, and you can click on “Investment, Finance” to pull up all of the posts on those topics.