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A decrease in the spending
amount during an extended
bear market is vital for improving
the sustainability of a
retirement portfolio.
PART 4 of 7 Series:
The Process of Managing Retirement Income

Retirees and their advisors should thoughtfully establish a spending plan to balance the desire to maintain a consistent lifestyle with preserving assets for a retirement that could last 30 to 40 years. 

To achieve this balance, a spending policy should be developed to determine what percentage of the retirement savings will be spent initially and how this amount will change over time to reflect the effects of inflation and the performance of the underlying investment portfolio.

A spending amount is defined as the amount of money withdrawn from the retirement savings to cover expenses. All too often they increase this amount annually by a cost of living adjustment as measured by the Consumer Price Index (CPI). This spending policy is referred to as a "lifestyle" policy since it is intended to provide for a consistent standard of living indexed to inflation.

The lifestyle spending policy, although attractive due to its simplicity, is flawed in two important areas.

   1. This policy does not tie the spending level to the performance of the underlying investment portfolio. As a result, the lifestyle policy never requires the retiree to slow or reduce the spending level during an extended bear market.

   2. In periods of high inflation, spending amounts may increase too rapidly, placing a retirement portfolio at risk of premature depletion.

Blended Approach Retirement Portfolio

Another policy is a blended approach, meaning it uses a percentage of the prior year's spending amount together with a percentage based upon the current portfolio value. When blended together; these two values determine the next year's spending amount. Having a percentage of the spending tied to the performance of the portfolio will increase or decrease the spending amount in tandem with the value of the retirement assets. A decrease in the spending amount during an extended bear market is a vital concept for improving the sustainability of a retirement portfolio.

Endowment Policy Retirement Portfolio

While the endowment policy is designed to lower the spending amount during a bear market, it does so on a gradual basis, thereby allowing the retiree time to adjust spending and stay on plan. Like the university endowments that use a similar policy, it can provide a balance between funding current operations while also preserving assets to cover future operations.

To begin using an endowment policy, retirees and their advisors must decide on two factors: what spending rate is appropriate and what smoothing rule should be applied, described as follows.
  • Spending Rate is the percentage of the portfolio value the retiree will use to determine their annual spending.
  • Smoothing Rule determines how quickly to increase or reduce the retiree's annual spending amounts based upon the portfolio's investment performance. Selecting a 90/10 smoothing rule assumes that 90% of the spending amount will be based on the prior year's spending and the 10% will be based upon the portfolio's current valuation.
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When using the endowment policy, retirees and their advisors can expect that spending amounts may not keep pace with the cost of living, unless the performance of the underlying investment portfolio grows sufficiently to support it. This slow "tightening of the belt" during bear markets is one of the keys to a sustainable retirement portfolio.

Following this strategy does not assure or guarantee sustainability of a retirement portfolio or better performance nor do they protect against investment losses.

Investments carry risks, including possible loss of principal. Investments in equity securities are subject to additional risks, such as greater market fluctuations. Bonds are subject to certain risks, including interest-rate risk, credit risk, and inflation risk. The principal value of bonds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. Investments in stocks and bonds are not FDIC insured, nor are they deposits of or guaranteed by a bank or any other entity.

The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.

Before investing, carefully consider the investment goals, risks, charges, and expenses. For a prospectus containing this and other information, contact your financial advisor. Read it carefully before investing.