Announcing the Motley Fool's Real Money Retiree Portfolios

By David Braze (TMF Pixy)

(Dec. 6, 1999) --Retirees face one question that hangs over them the rest of their lives after retirement: How much can we withdraw from a portfolio and still remain reasonably certain that our money will last as long as we do? And can we increase our withdrawals each year to ensure we maintain our purchasing power?

The answer, of course, depends on how your money is allocated (i.e., the percentage invested in stocks versus that invested in short-to-mid-term bonds), the initial amount taken from that portfolio, and how long withdrawals must last.

I recently conducted a study of "safe" withdrawal rates using the Foolish Four (FF) stock strategy. The study is based on FF history for the years 1961 through 1998. The results of that study are in an article I wrote about Foolish payouts, which will launch next week with a brand new Fool area devoted exclusively to retirement concerns. I thought it would be interesting to use the results of that study in a real money Individual Retirement Account portfolio owned by a real retiree -- me. After all, I've retired twice already, so I qualify. In fact, some Fools insist I'm still retired even though I'm slaving away in Fooldom every day (for a mere pittance I might add). So (trumpets please), get ready for the new Motley Fool Retiree Portfolios! Yup, you read that right. Portfolios -- plural. But I'll get into the details in a moment.

We'll give you a sneak preview of my findings here. This article shows the success rates for various withdrawal rates over various time periods for various portfolio mixes. Based on that 38-year period, the study revealed that a 100% FF portfolio was 100% successful over all time periods in sustaining an inflation-adjusted initial withdrawal rate of 6% (Table One). Success rates remained reasonably high for all payout periods through an 8% initial withdrawal rate, but declined significantly at higher payouts.

A portfolio of 75% FF and 25% bonds using an initial 6% withdrawal rate was also successful in every time period. At a 7% withdrawal rate there was a degradation in success rates as compared to the 100% FF Portfolio, and that degradation continued at higher withdrawal rates. In a 50% FF/50% Bond Portfolio, the 100% success rate was sustained only at a 5% initial withdrawal, with a marked decline in success at higher payout rates.

I made a similar comparison substituting the S&P 500 Index for the FF (Table Two). That analysis revealed that a 100% success rate for each portfolio containing the S&P could be sustained for all payout periods only at a 3% withdrawal rate. Use of a 4% withdrawal rate had a reasonable probability of success only in the 100% S&P and the 75% S&P/25% bond portfolios. None of the portfolios had a good probability of success using a withdrawal rate of 6% or higher save for the shorter payout periods of 15 and 20 years. Even then, they were mediocre at best and significantly lagged the FF portfolios.

Therefore, I talked the powers that be at the Fool into letting me use my own money (they liked that part) to establish and report weekly on three retiree portfolios that use the Foolish Four as a core holding. Think of these three IRAs as Aggressive, Moderate, and Conservative, even though I've come up with more upbeat names than that. All three encompass the typical risk levels desired by most investors. Each will be funded with $100K from which a retiree -- that's me again -- will take his first withdrawal, leaving the rest to accumulate until next year's payout. The portfolios and initial payouts are as follows:

  • *Racy Retiree (the aggressive one). The first withdrawal will be $8K (or 8%), with the remaining $92K invested entirely in the FF.
  • *Reasonable Retiree (the moderate one). The first withdrawal will be $6K (or 6%), with the remaining $94K invested to hold 75% in the FF and 25% in bonds.
  • *Reluctant Retiree (the conservative one). The first withdrawal will be $5K (or 5%) with the remaining $95K invested to hold 50% in the FF and 50% in bonds.
I'm lazy, so the rules for these portfolios will be quite simple. They are:
  • Everything will be as mechanical as possible to ensure no deep thinking will be involved.
  • All trades will be conducted annually on December 10, or the first business day thereafter if the 10th is a nonbusiness day.
  • After the initial withdrawal, each succeeding year's payout will be adjusted based on the October to October change in the Consumer Price Index - Urban.
  • Annual income will be taken prior to annual trades and reallocations.
  • Mandatory IRA withdrawals will be made at age 70 1/2, and any excess income will be reinvested in a taxable account under rules to be determined at that time.
  • Withdrawals exceeding those of inflation-adjusted income may be taken at the discretion of the IRA owner.
  • Bond investments will be evenly split between the Vanguard Short-term Bond Index Fund and the Vanguard Total Bond Market Index Fund to dampen volatility and to keep bond selection simple.

We could argue about why I'm using short-term and intermediate-term bond index funds instead of actual bond instruments, but we won't. I told you -- I'm lazy. I don't want to do the research on individual issues, nor do I wish to construct a bond ladder of any type. Therefore, no-load bond index funds it is. We could also say Racy Retiree is too exposed in that he has everything in stocks. After all, Fools always say money you know you'll use in three to five years should never be in stocks, right? But my response to that is "So what?" Racy Ralph's an aggressive type of guy and wants to run that risk. It's his money, so we'll let him.

The sole purpose of these portfolios is to show folks what can and will happen when a person uses one of these three strategies. I believe in the value-oriented approach found in the FF, and I believe most strongly that a FF investment method can be of value to retirees. I do not, however, guarantee its success. But I also see nothing evident in the near future that tells me another approach is better, either. Therefore, for me, its use seems appropriate. You, though, must decide for yourselves whether it is appropriate for you.

And there you have it, a Retiree Portfolio to fit most tastes. It will be boring, and it will be ho-hum. That's why this will only be a weekly column, but what a column it will be. Sure, you'll get the return stats, but that's not all. Each week we will cover a topic of interest to retirees by talking about such stuff as Medicare, long-term care insurance, estate planning, and the like. Got something special you want to hear about? Post it on the retirement investing message board and I'll take it under advisement. Want me to expound more on the Retiree portfolios and safe withdrawal rates? Just fire off your questions, and I'll see if I can get a column or two out of them.

In the meantime, enjoy your week. Next week: The kickoff of the portfolios in a brand-spankin' new area devoted to retirement issues.

Best to all.

-- TMF Pixy