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Note: The featured
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opinions expressed herein are not necessarily those of MFI or BES,
Inc.
Investing During Retirement - Part II,
cont'd
A Comprehensive Approach
by Frank Armstrong
President, Investor Solutions, Inc.
www.fee-only-advisor.com
 Withdrawal
Strategy – Preserve volatile assets in down markets
A rational withdrawal strategy will recognize that equities
are volatile and short-term bonds are not. So, we employ a specific strategy
designed to protect volatile assets during down market conditions. Otherwise,
excessive equity capital will be consumed during market downturns.
Most advisors have been content to treat retirement assets
as a single portfolio. For instance, many would advocate a “life style”
portfolio comprised of 60% stocks and 40% bonds. However this leads to
withdrawals on a pro rata basis from both equity and fixed assets regardless of
market experience. It does nothing to protect volatile assets during down
markets.
A far superior alternative strategy would treat the equity
and bond portfolios separately, then impose a rule for withdrawals that protects
equity capital during down markets by liquidating only bonds during “bad”
years. During “good” years withdrawals are funded by sales of equity shares
and any excess accumulation is used to re-balance the portfolio back to the
desired asset allocation. Again, using spreadsheet models with Monte Carlo
simulation we find substantial incremental improvement by imposing this simple
rule.
Implementation
In all cases, implementation is via no-load institutional
class index funds. This policy spreads risk as widely as possible in some of the
world’s most attractive markets while controlling costs, preventing “style
drift”, minimizing taxes, and eliminating “management” risk.
Evaluation of Alternative Strategies
Finance has been silent on the question of where on the
efficient portfolio an investor should choose to invest. Monte Carlo Simulation
gives us a powerful tool to evaluate alternative strategies. For instance,
should an investor needing a 6% withdrawal rate invest in a portfolio with a 10%
return and a 12% standard deviation, or one with an 11% return with a 15%
standard deviation? Does this answer depend on the time horizon? Does the answer
change if the withdrawal rate changes? Here Monte Carlo Simulation can guide us
to the best choice depending on the investor’s unique requirements and goals.
The correct choice is the one with the highest probability of success.
We can also stress test our assumptions. For instance, what happens if we have
volatility right but rate of return falls 2% short of our estimate?
Next: Frank
talks about planning the transition to retirement, estate taxes, and making your
savings last.
Copyright ã 2000 Francis C. Armstrong
Frank Armstrong, CFP, is the author of Investment
Strategies for the 21st Century, published here,
President of Managed Account
Services, Inc., a fee-only Registered Investment Advisor, and Chief
Investment Strategist of DirectAdvice.com.
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