If we didn’t try so hard, retirement planning would be easier. Perhaps better (or perfect) is the enemy of good. Maybe we should consider the notion that the simple solution is the best solution. It can answer the two questions that vex people the most:
— How much can I spend from retirement investments and maintain purchasing power?
— Will I run out of money before I die?
Using Simple Tools
In fact, we can answer those questions using two simple tools. The first is a dirt-cheap, no-brainer-simple index fund portfolio. The second is limiting our retirement spending to Required Minimum Distributions. That’s right, those pesky IRS rules that tell us how much to take from our retirement accounts turn out to be a good guide for spending.
But don’t take my word for it. You can test this for yourself, with your own retirement fund figures, on a free website. The website is www.portfoliovisualizer.com.
Here are some of the things I learned building and testing simple portfolios. Distributions begin at 3.65 percent at age 70. Let’s start with the dirt simple index fund portfolio.
We’ll also say you have a retirement nest egg of $1,000,000. Most people don’t, but pretending won’t hurt anyone. Let’s also say that you can divide by two with the help of an electronic calculator. Then you put half of your money in a total domestic stock market index fund. You put the other half in a total domestic bond market fund.
How would that go? Here is what I learned using the Monte Carlo simulation tool on the portfolio visualizer website. (No, this isn’t simple. It simulates thousands of investment periods and tells us the results over a 30-year period. It’s a tool for understanding how results may vary.)
Six Lessons from Monte Carlo
— Lesson one: You won’t run out of money. You may have less money than you began with. But since you’re always taking a percentage of your previous year-end assets it’s impossible to hit zero.
— Lesson two: Your income is pretty nice. At the end of the first year, the initial withdrawal would be $36,629. That would happen if your portfolio performance had been at the 25th percentile level. In other words, you could start withdrawals in a lousy time for the market— and still withdraw a pretty good amount. (If the market did better that first year, you could start with more. You would take $42,486 after a median year, $46,289 for a top 25 percent year.)
—Lesson three: Your purchasing power would rise for a long time— 23 years. So your standard of living could increase from age 70 to age 93. This would happen even if your investment results were in the bottom 25 percent of all time periods. For that simple Couch Potato portfolio, your real income in year 23 figured to $56,656.
—Lesson four: Your long-term income isn’t so bad, either. Your spendable real income would peak at age 93. But it would be higher than your starting income, adjusted for inflation. For the 50/50 Couch Potato at the bottom 25th percentile, income was $45,711 at age 100.
—Lesson five: You may die with less money than you started with, but most won’t. If you live to age 100 and are at the 25th percentile for portfolio returns, you’ll die with less money than you started with. But on the off chance that you die before reaching age 100, odds are you will die with at least as much money as you started with.
—Lesson six: Most people will die while their spending power is growing. Their retirement nest eggs will still be growing too. At age 93, only 10 percent of men will still be alive, and only 19 percent of women. In couples, there is a 73 percent chance both will be dead.
Can you do better than utter simplicity?
Of course you can! You can increase to a 60/40 or a 70/30 stocks/bonds mix. You can add REITs to the mix. You can reduce domestic stocks and add international or emerging markets stocks. You can make it as complicated as your heart— or your financial advisor— desires.
But there is no certainty that you’ll get better results. More important, your pursuit of better (or perfect) may cause you to lose sight of a good solution.
Can you do worse? That’s possible, too. Remember, 25 percent of the time, results will be worse.
———————————————————————————————-
On the web:
Portfolio Visualizer website: https://www.portfoliovisualizer.com/monte-carlo-simulation
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo: Scott Burns, Boston Harbor, 2016
(c) A. M. Universal, 2016