Category Archives: retirement income

How Much Do You Need to Save for Retirement?

In the financial advisory business, one of the most pressing and controversial topics is how much money people need to save during their working years in order to provide for long-term retirement income.  The research on this topic has evolved quite a lot in recent years, and a recent issue of Money magazine features a series of articles representing the current view on this critical topic.  These articles, based around interviews with a number of the current thought leaders on this topic, deserve to be widely read and discussed.

The series of articles in Money kicks off with perspectives by Wade Pfau.  Pfau’s introductory piece suggests a difficult future for American workers.  A traditional rule-of-thumb in retirement planning is called the 4% rule.  This rule states that a retiree can plan to draw annual income equal to 4% of the value of her portfolio in the first year of retirement and increase this amount each year to keep up with inflation.  Someone who retires with a $1 Million portfolio could draw $40,000 in income in the first year of retirement and then increase that by 2.5%-3% per year, and have a high level of confidence that the portfolio will last thirty years.  It is assumed that the portfolio is invested in 60%-70% stocks and 30%-40% bonds.  The 4% rule was originally derived based on the long-term historical returns and risks for stocks and bonds.  The problem that Pfau has noted, however, is that both stocks and bonds are fairly expensive today relative to their values over the period of time used to calculate the 4% rule.  For bonds, this means that yields are well below their historical averages and historical yields are a good predictor of the future return from bonds.  The expected return from stocks is partly determined by the average price-to-earnings (P/E) ratio, and the P/E for stocks is currently well-above the long-term historical average.  High P/E tends to predict lower future returns for stocks, and vice versa.  For a detailed discussion of these relationships, see this paper.  In light of current prices of stocks and bonds, Pfau concludes that the 4% rule is far too optimistic and proposes that investors plan for something closer to a 3% draw rate from their portfolios in retirement.  I also explored this topic in an article last year.

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60-Second Retirement Savings and Income Checkup

I think that the American public has largely tuned out the myriad studies showing that most households are woefully under-saving for retirement.  Even if we’d prefer not to think about this issue, however, it is crucial to regularly check on how we are doing.  There are two major questions.  First, during your working years, are you saving enough?  Second, during retirement, how much income can you sustainably plan to draw from your savings each year?  The good news is that there are some simple tools that you can use to do a fast estimate of how you are doing, how much you need to save to stay on track, or how to get on track. Continue reading

One Advisor’s Approach to Income Investing

Guest post by Contributing Editor, John Graves.

Editor’s Note:  John Graves has been an independent financial advisor for 26 years. He is one of the two owners of The Renaissance Group, a Registered Investment Advisor based in Ventura, CA.  John’s book, The 7% Solution: You Can Afford  a Comfortable Retirement, was published in 2012.  When I read this book, I was impressed with John’s approach and thinking and I recommend it as a good read.  I contacted John and asked if he would consider contributing to this blog.  After we bounced around some possible topics, he sent me the following piece that describes his process for designing income plans for retirees.  Continue reading

An Alternative Approach for Drawing Income from Your Portfolio

The question of how to safely generate income from a retirement portfolio is one of the most challenging in financial planning.  In the days when people had traditional pensions, their employers simply promised them a constant inflation-adjusted income for the duration of their retirements.  As we have moved away from traditional pensions and into self-directed savings plans such as 401(k)’s and IRA’s, investors and advisors must create their own customized income plans.  New research from Morningstar highlights what appears to be a better approach to creating a stable income stream from an investment portfolio. Continue reading

Sector Watch: Municipal Bonds

Municipal bonds are issued by states and municipalities and typically have tax advantages relative to other fixed income assets.  In general, income from muni bonds is tax exempt at the federal level and at the state level for investors living in the issuing state.  Municipal bonds have historically been favored by investors in high tax brackets who, of course, derive more benefit from the tax exemptions by virtue of being in the highest tax brackets. Continue reading

Saving and Investing for Retirement: Part Five

Effective Actions in an Uncertain World: Part Five of Our Special Five Part Series

There are a number of factors that we need to predict in order to come up with saving and investing strategies for retirement.  The values that we assign to these factors will have a huge impact on whether or not we will be able to meet our goals.  First, there is the expected return that investors will make on their retirement savings.  Second, there is the common estimate that people will need about 85% of their pre-retirement income to support them once they stop working.  Finally, there is the potential impact of behavior on savings rates, investing, and spending.  Continue reading

Saving and Investing for Retirement: Part Four

Generating Income: Part Four of Our Special Five Part Series

During their working years, investors focus on saving and investing with a goal of building wealth.  As they enter retirement, either by ceasing paid employment entirely or by scaling back paid employment, investors shift their focus to using their portfolios to provide a reliable long-term stream of income.  This transition from building wealth to income generation is the subject of a great deal of research in retirement planning.  Once investors are at or near retirement, the most significant financial challenge is using their accumulated savings to provide substantial income for their retirement years.  Continue reading

Saving and Investing for Retirement: Part Three

Realities of Investing: Part Three of Our Special Five Part Series

In the various calculations that project retirement portfolio accumulations through time (such as the two discussed in the previous article), there are assumptions about how investors will allocate their savings and how those investments will perform.  In the case of the Fidelity study, no specific asset allocation is provided that would achieve the assumed risk-free 5.5% annual return.  In the Ibbotson study, the authors assume that investors hold a combination of a stock index fund and a bond index fund that progressively allocates less to stocks and more to bonds as investors get older.  The Ibbotson study also assumes that the stock index (the S&P 500) will have an average annual return of 10.96% per year and that the bond index will have an average return of 4.6% per year.  The Ibbotson study ignores expenses associated with investing. Continue reading

Saving and Investing for Retirement: Part Two

Figuring Out Whether You Are On Track: Part Two of Our Special Five Part Series

Fidelity just came out with a study that estimates that people will need about eight times their final salary level, assuming they work until age sixty seven, to be able to retire and subsequently to have 85% of their pre-retirement income provided from retirement savings plus social security.  Fidelity also helpfully provides estimates of what they believe people need to have acquired at different ages. Continue reading

The Challenge of Long-Term Income: Part II

In Part I of this article, I explained why I have issues with the traditional idea that individuals should provide for their required level of retirement income (beyond what is provided by Social Security and any pensions) entirely with assets with zero risk of loss of principal (e.g. Treasury bonds).  In Part II, I discuss the alternative approaches.

There are two investments that have zero loss of principal: traditional Treasury bonds and Treasury Inflation-Protected Securities (TIPS), which are Treasury bonds with embedded protection against inflation.

I agree with the notion that people need to save and invest so as to be able to provide a very reliable and consistent income stream in retirement.  Zvi Bodie has presented a compelling argument that investments in stocks do not become less risky as you hold them for longer periods, so that investors cannot rely on stocks as part of their required income stream.  I have performed detailed analysis of Bodie’s argument and I agree with his argument: the magnitude of loss that you can face with an equity-heavy portfolio increases the longer you hold the portfolio.  As I noted in Part I, William Bernstein has recently advocated for a portfolio in which all of your required income is provided by Treasuries and annuities, largely consistent with Bodie. Continue reading