How To Avoid Running Out Of Money In Retirement

by: Lowell Herr

As promised, here is the Quantext Portfolio Planner (QPP) retirement analysis using the Kenilworth Portfolio as an example. The first screen shot shows the assumptions involved in the analysis. The second slide is familiar to Platinum readers as it lays out the investments and percentage in each. The third slide is the scary one as it presents the grim details or the probabilities of running out of money during the retirement years. Let's take them one by one.

Assumptions: This investor is 45 years old with a savings of $200,000. She is putting away $7,000 per year and the inflation rate is projected at 3.5% per year. The retirement income is a modest $50,000 per year from this portfolio alone. This annual salary in today's dollars does not include income from social security or income from a possible pension. Look over the assumptions and if you want to change something, make a suggestion in the comments section.

Click to enlarge

Portfolio Data: In the following slide we have the current Kenilworth Portfolio. Note the high (18.8%) value for the standard deviation. If we are disciplined and appropriately use the ITA Risk Reduction model, we should be able to lower portfolio volatility to something well below 15%. That will help to stretch out the life of this portfolio during the retirement years. However, don't count on this as the final solution.

Click to enlarge

Monte Carlo Probabilities: And now for the sobering news. This investor can assume a 10% probability of running out of money at age 72 or just a mere six years after retiring. There is a 50% chance of falling short at age 84. Instead of age 84, I want to see the age something above 100. In other words, I want to see a very low probability or running out of money.

The solutions are limited. As shown in some of the referenced articles yesterday, one can work longer. For example, working till age 70 pushes that 50% chance of running out of money up to age 92. That is a huge difference.

Saving more each year is also a possibility. That certainly will help. We might adjust the portfolio asset allocation, but that is not a sure thing. Remember, these are only probability suggestions. Nevertheless, it is worth a try to build a portfolio that has a lower volatility projection.

Living on less is another possibility. If the investor has no pension and social security is facing a political "firing squad," the $50,000 value may reasonable. This investor can only hope a rich uncle will include them in the will.

Click to enlarge