As a retirement income planner, my job is quite different from that of a broker or money manager.

For people who have been working all theirs lives to grow their nest egg, it’s my job to help them figure out the best way to spend it. Many people rely on the guidance of the adviser who helped them grow their money. For some, this works out fine, but for others, not so much. As it happens, spending your money is much different from growing it, and unless your planner understands this, your “Golden Years” can turn to rust.

Here’s an example.

During the time you have been accumulating your nest egg, you have probably, at the behest of whoever is guiding you, been employing a technique called “dollar-cost averaging.” This is a method of investing where you purchase the same dollar amount of a mutual fund or other security on a regular and frequent basis, for example every week or every month. The notion is that since you will purchase some shares at lower prices and some at higher prices, you will, on average, be able to accumulate more wealth than if you just invested sporadically or in an attempt to “time” the market. This has proven to be a very effective strategy.

When you spend your money, however, this strategy that worked so well before can be the kiss of death. Imagine that you have $300,000 saved and you want to take $1,000 per month from your savings (the classic 4 percent rule). Also assume that your portfolio is made up of 30,000 shares, each priced at $10. That means you would have to sell 1,200 shares a year, or 100 per month. Now assume we have a decade like the 2000s when you have two market drops of more than 40 percent in one 10-year period. Each time the market plummets, the number of shares you must sell to live goes up, and when the market inevitably recovers, you don’t have the shares needed to recover with it.

This concept was brought into specific relief in January 2011 when T. Rowe Price released a study of how the 4 percent rule would have held up during that decade, using a technique called “Monte Carlo Planning.” This is a method of planning whereby a sophisticated “what-if” analysis is used to try to predict how much money you can spend from your savings without running out. Before 2000, it was thought that people could safely spend 4 percent of their income with a 3 percent annual inflation adjustment, and have an 85 percent to 90 percent chance of not depleting their fund over a 30-year period. Monte Carlo simulations routinely held this to be true.

The T. Rowe Price study blew this theory to smithereens. It found that without adjustment, the typical 4 percent withdrawal plan would have had a meager 6 percent chance – that’s a 6 percent chance – of success (i.e., not running out of money). The study did, however, provide recommended alternatives to improve chances of success. For example, if you were willing to forego the inflation adjustment for six of the 10 years of the decade, you could raise your odds of success to 26 percent. Alternatively, if you would reduce your total spend by 25 percent for three years after each market bottom, you could increase your odds to 43 percent. A copy of the study can be downloaded at www.freemoney
guys.com.

It turns out, then, that retirement income planning isn’t so much about rates of return as it is risk management.

There are “seven deadly risks” that we have identified that can decimate a retirement plan. They are market risk, longevity risk, inflation, taxes, probate, creditors (lawsuits, etc.) and health and long-term care risks.

In this case, the risk that killed the plan was market risk. Over the next several months, we shall explore some of the other risks for which to watch out.

Stephen Kelley is president of Safety First Financial Planners in Nashua. Steve and his partner, Mark, can be heard on the “Free Money Radio Hour” every Tuesday and Wednesday at 9 a.m. on WSMN 1590 AM, Nashua, and Sundays at noon on WCAP 980 AM in Lowell, Mass. He can be reached at steve@safety1stfp.com, and his website is www.safetyfirst
financialplanners.com. His column runs the fourth Wednesday of the month.

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