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Accounting for the Real Costs
You may be thinking, "Wait a minute! We did that already when we figured out how much retirement was going to cost. We used those numbers in the retirement calculator along with our annual savings amounts, inflation rates, and investment returns. The calculator has already told us whether or not our intended withdrawals will last throughout retirement, so whaddaya mean we haven't looked at that issue yet?" (Of course, your thoughts might not be as wordy.)

Well, it's like this: Retirement planning calculators are useful tools, and they serve a valuable purpose. However, perhaps the worst defect is that the vast majority relies on average rates of return and inflation. Over the long term, an average rate will work. That's especially true when you're still saving for retirement. Unfortunately, year-to-year results won't be the same as the average, and to a retiree who is taking, instead of saving money, those yearly variations can be devastating. It's very much as though you were forced to sell stocks on margin -- when the price was depressed and you didn't want to sell.

Timing Is Everything
Ibbotson Associates tells us that for the years 1926 through 2000 the average annual S&P 500 total return was 11.1%, the annual average total return for long-term corporate bonds was 5.7%, and inflation averaged 3.1% per year. That means a portfolio constructed of a 75% holding in the S&P 500 and a 25% holding of long-term corporate bonds would have produced an annual total return of 9.76%, on average. As a retiree, I could look at that result and conclude I could take nearly 7% of my portfolio yearly and not be fearful of running out of money. After all, if it's growing at almost 10%, inflation is about 3%, and I'm just taking 7%, I'm set for life, right?

Well. What if you were unfortunate enough to retire on January 1, 1964? For the 15-year period that began then, the S&P 500 total return averaged 5.4% per year, long-term corporate bonds averaged 4.0%, and inflation averaged 5.4%. You'd have averaged a total return of only 5.1% per year through the end of 1978 -- less than the average inflation rate.

Think about the first year's 7% withdrawal. Now realize that, in order to draw the same amount of money in subsequent years, you'd have to increase that amount each year by the inflation rate. Then ask yourself if you could have survived those 15 years intact. Not a chance, Fool. You'd be eating government surplus cheese by now. (Of course, if you'd retired at age 60 in 1964 you'd be 97 now, so something in that cheese suits you.)

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