Many of the 10,000 baby boomers who are turning 65 each day are looking forward to retirement. But how many of these baby boomers, and current retirees know how to manage their savings well enough to avoid running out of money in retirement?
An investment quiz developed by The American College of Financial Services was given to 1,244 individuals between the ages of 60 and 75 with at least $100,000 in savings to determine how much they knew about managing money in retirement. A score of 60% or higher was considered a passing grade.
The following are the dismal results:
• The average respondents score was 47%
• 74% failed the quiz
• Only 5% scored 80% or higher
I am not at all shocked by these results. One of the biggest and most common mistakes retirees make when it comes to managing money during retirement is relying on “average returns.” Many retirees are under the impression that if their retirement savings averages 6 or 7% they should be able to withdraw 6 or 7% of income and never run out of money. Nothing could be further from the truth.
In a recent column, “Minimizing losses can increase returns,” I discussed how important reducing volatility and losses can be when saving money for retirement. However, the damage that volatility and losses can have while saving for retirement pales in comparison to the effect they can have on retirees withdrawing income from their savings during retirement. To illustrate the powerful impact that volatility can have on a portfolio during the distribution phase of retirement, consider the following example:
Two portfolios each start with the same amount of money, $500,000, earn the same average return, 7%, and withdraw the same amount of income each year, $35,000. With the same amount of initial savings, the same average returns, and the same annual withdrawal, you would think that both portfolios should end up with the same ending value.
However, the differences in the volatility of annual returns between the two portfolios results in quite different outcomes.
After 10 years, Portfolio A, the significantly more volatile portfolio, was worth $343,762, and Portfolio B was worth $434,456; a difference of more than $90,000. A chart showing the actual performance of these portfolios can be located at “Investment Articles” on the website, capitalwealthmngt.com.
When it comes to retirement, designing a portfolio that seeks to provide more consistent returns and that preserves capital by minimizing volatility and losses is critical to the long-term growth of your savings. Volatility and negative returns combined with annual withdrawals means smaller savings balances will compound, thereby increasing the likelihood that your retirement funds may run out before the end of your retirement.
Martin Krikorian is president of Capital Wealth Management, a registered investment adviser providing fee-only investment management services at 9 Billerica Road, Chelmsford. To schedule a free, no obligation, portfolio risk analysis call 978-244-9254 or email [email protected]