Retiree Portfolio Who Woulda Thunk?

By David Braze (TMF Pixy)
December 13, 1999

Since last week's Special Feature in which I outlined my three new, real money Retiree Portfolios, I have been overwhelmed with e-mail. I've received hundreds of missives from Foolish readers, many with great suggestions for future columns and many with questions about the portfolios themselves. (Note to self: Avoid using your own e-mail address to solicit responses in the future.) I never dreamed there were so many Fools who were so interested in the issues confronting those nearly or already retired. It's obvious we struck a chord with this concept. I'll use the suggestions as fodder for future columns, and I'll address some of the major questions later on in this piece. First, though, comes the news.

Our newly expanded Retirement Area is alive and well. It's chock-a-block full of useful tips and Foolish information for those nearing or in retirement. So after you're done reading this piece, go ahead and make my day -- just kick back, take off your shoes, and open the first of thirteen fact-filled Foolish articles. If you have questions about the articles, want to comment about this column, or want to ask a retiree-related question in general? Just post away in the Retired Fools message board. It's been relatively quiet lately, so perhaps we can liven it up some.

As for the Retiree Portfolios, the necessary purchases were made uneventfully on December 10 as promised. You can check the number of shares, the holdings, the purchase prices, and current values here. Remind me, though, to tell you in a future article about the fun time I had getting the necessary funds from my brokerage IRA to a Vanguard IRA. My long-departed mother-in-law should have had such an experience. On second thought, maybe not. I don't want to be too cruel. I might see her again someday.

Now on to the questions many of you posed regarding the portfolios. I've listed them in no particular order, and I've chosen those that appeared most often in your messages to me.

Q. Why did you select December 10 as your annual trading date? Is there some market significance there?

A. There is no special significance to the date. Because December and January historically have been the best months to begin a Foolish Four strategy, I simply wanted my trading date to fall between December 1 and January 15. For income tax reasons, I preferred December. December 10 was chosen based on internal production dates for getting the expanded retirement area up and running. Additionally, I wanted to announce the portfolios prior to their actual purchase to comply with Foolish policy concerning advance public notice of pending trades.

Q. I like the 8% withdrawal rate. Do you recommend I start a Racy Retiree portfolio?

A. Let's make something perfectly clear. I recommend nothing. That has to be a personal decision on your part, and it should be one made with a clear understanding of the risks involved. Your retirement portfolio must last you for the rest of your life, and how you withdraw the money is important. How much you take, how it's invested, and when you start all play a vital role in that decision. I discuss these issues in detail in three successive articles starting with Investing Your Nest Egg Foolishly. I urge everyone to read them before electing to follow any of these three portfolios.

I believe strongly in a Foolish Four strategy. My analysis of Foolish Payouts confirmed its superiority over an S&P 500 approach for the period 1961 to 1998. That does not mean, though, that what happened then will happen in the future. There are no guarantees here. Still, I see nothing to suggest use of the Foolish Four is no longer viable. Therefore, I have concluded it is appropriate for me. You must decide whether that's also true for you.

As to the Racy Retiree portfolio, it takes its name because it is invested totally in stocks, and only four stocks at that. Many would cringe at such limited diversification. Secondly, it starts withdrawals at 8%, a very large payout for conventional portfolios that easily leads to failure over time. My historical analysis shows a Foolish Four portfolio using that withdrawal rate went bust in three out of the nine possible 30-year periods between 1961 and 1998. Sure, that's better than a similar S&P 500 portfolio because all of those failed. But it still means the Racy Retiree portfolio modeled here has the potential to fail one out of three times. Do you want to run that risk? If not, look at a lower withdrawal rate. As an example, none of the nine possible 30-year Foolish Four portfolios failed using an initial withdrawal rate of 6%, but all of the S&P 500 portfolios failed.

These three portfolios are presented to show folks what will happen to someone using the asset allocation and withdrawal rates specified for each. The Racy and Reluctant portfolios illustrate the two extremes while the Reasonable portfolio represents the middle ground. Imitate them at your own risk. Better yet, study the tables on success rates in the Foolish Payouts article and develop your own strategy. Just don't follow me blindly. Understand what's involved first. If you want to ride the big horse, know and appreciate that you could fall off.

Q. Are you considering the impact of income taxes on your portfolio withdrawals? If not, why not?

A. No, I am not. The various rates of withdrawal were established based on the historical success rates found in the article on Foolish Payouts and my subjective judgment on the risks involved in each. Income taxes vary from person to person and are far too difficult to model as a general example. Instead, my interest lies in showing folks how various portfolios will survive using a different allocation approach and different withdrawal rates. The important issue here is not, at least in this Fool's opinion, the net income after taxes. Instead, it's how the portfolios survive using a particular allocation and withdrawal rate.

Q. In the Reasonable Retiree Portfolio, do you take 6% every year? And how do you decide how many and what stocks to sell, or does it all come from the bond funds?

A. As far as the Retiree Portfolios are concerned, the initial rates of withdrawal were established based on my subjective judgment of the success of the various portfolios using those rates over the years 1961 through 1998 for the various withdrawal periods. In the Reasonable Retiree Portfolio I decided to take a 6% initial withdrawal because in a 75% Foolish Four (FF) and 25% bond portfolio it was successful over all time periods analyzed. Therefore, using that portfolio, I start with $100K from which I take $6K for income. The remaining $94K gets invested as 75% ($70.5K) in the Foolish Four and 25% ($23.5K) in bonds.

I now reach my anniversary date at the end of the year. At that time I note the inflation rate for the year was 2.5%. That means the income I want for year two is $6,150 ($6K X 1.025). Suppose the market value of my portfolio is $80,370 for the FF and $25,028 for the bonds, or $105,398 total. I subtract the $6,150 from the $105,398 to get $99,248. Of the $99,248, I want $74,436 invested in my new FF (75%) and $24,812 in bonds (25%). I take the $6,150 in cash, and readjust the FF and bond holdings to reflect the allocation desired.

At the end of year two, I repeat the process, except that the inflationary increase in income is now applied to the $6,150 in income I took for year two. The use of the FF (which requires annual adjustments) and bond funds (which are easily traded) makes the process very quick and easy. I don't have to agonize over which or how many shares of stock to sell, and I don't have to worry about bond maturity dates.

That's it for the major questions. Got more? Hustle over to the Retired Fools message board (heck, even "bookmark" it!) and post away. I'll do my best to answer.

See you next week. In the meantime, remember my motto: "Ya makes your choices and ya lives with the results."

Best to all...