Spend The Income Or the Assets?

By Martha M. Hamilton
Sunday, September 16, 2007

It seems simple enough. When it comes time to live off your retirement savings, it would seem to make sense to spend without chipping away at the nest egg itself. Instead, you would want to switch your portfolio to income-producing investments and live off the income. That way you would have money for expenditures and your investments would remain whole and protected.

Turns out it's not that simple.

I used to think that a portfolio switch was the way to go after hearing friends say they were trying it. But, as is often the case in the complicated world of financing your retirement, there's more to it.

"It's a way of thinking that we try to talk a client out of," said Marjorie L. Fox, a principal in Fox, Joss & Yankee, a fee-only financial planning and investment management firm based in Reston.

She said she warns her clients away from the income-only approach because "they may, in the pursuit of income, limit the growth in the portfolio that they may need if they have a long retirement horizon."

And more of us will have a "long retirement horizon" than we think we will, according to a survey by the Fidelity Research Institute. Fidelity found that retirees on average estimated that they needed enough savings to last until age 85, while pre-retirees estimated an even shorter span -- to age 83. Yet actuarial studies from 2000 indicate that 23.7 percent of men and 34.8 percent of women who reach their 65th birthday will live to age 90. Those could be a tough five years for those who were spending on the assumption that they would die earlier.

Interestingly, the Fidelity study noted that a 65-year-old man has about an equal chance of dying before age 70 or living to age 95 (7.8 percent vs. 7.7 percent). "The fact that the actual length of a retirement period could be 5 years or 30 years dramatically impacts the sustainability of a spending plan," noted study authors W. Van Harlow, managing director of Fidelity Research Institute, and Moshe A. Milevsky, business professor at York University.

That's why we should care about making our assets grow in retirement unless we have fabulous pensions or enough annuitized income to ensure we'll have more than Social Security to depend on in our final years. (That's for those of us who are lucky enough to have additional sources of retirement cash. Social Security is the sole source of income for about a quarter of all retirees.)

Fox said she uses a simple example to explain to her clients why they may not want to focus exclusively on income. For example, she said, take a client with a portfolio worth $1 million at retirement who needs to spend $40,000, or 4 percent of total savings, per year. Producing a 4 percent return from income only (as opposed to selling assets in the portfolio) generally requires investing in lower-growth assets such as bonds or dividend-paying stocks. As a result, the new portfolio might grow in value by only about 2 percent, for a total annual return of 6 percent.

But the client might be able to reach the same spending goal through a combination of income and selling assets that would be likely to result in a greater overall return. For example, the client could take $30,000 -- or 3 percent -- in income if she were also willing to cash in $10,000 in assets and leave more of her portfolio in growth stocks. If her portfolio grew by 5 percent, her total return would be 8 percent.

Anthony Webb, a research economist at the Center for Retirement Research at Boston College, said he thinks a single-minded focus on income-producing stocks probably isn't the best approach. He said he probably had erred in configuring his portfolio to maximize income from dividends and interest. "The more I think about it, it's illogical and arbitrary, and I shouldn't be doing it," he said. "The problem is, if you chase after dividends, you tend to end up with an unbalanced portfolio." For example, he said, he invested heavily in banks for their dividends. Lately -- thanks to the subprime-mortgage mess -- that's not a good place in which to be concentrated.

Growth helps your money last and helps offset inflation. So structuring withdrawals to emphasize growth is probably a good idea.

If you have subjects you would like to see addressed in future columns, please e-mailhamiltonm@washpost.com.

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