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Course 508
Is Your Retirement Portfolio on Track?

Introduction

You will not work a day beyond your 55th birthday. And you plan to spend your retirement days sipping lemonade on Capri and stiffening your neck by watching two weeks of tennis at Wimbledon. You have no intention of being a stay-at-home retiree.

You might not have much choice, though.

Based on the most recent statistics, many households won't have what they need to maintain their current standard of living in retirement, let alone fund posh trips. According to a study from the Center for Retirement Research, the current gap between U.S. households' retirement savings and the amount they'll actually need in retirement is a yawning $6.6 trillion. (That figure encompasses the savings of both younger individuals as well as those who are closer to retirement.)

Determining whether your retirement nest egg will cover you or fall short is a complicated exercise, and unfortunately, the numbers won't always tell you what you want to hear. However, the advantage of checking up on when and how you might be able to retire is that it can help you determine whether changes are in order while there's still time to make them. You can work longer, save more, or spend less; you can also recalibrate your planned spending during retirement or make changes to your investments in an effort to optimize your returns.

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What's Your Starting Point?

The first step in assessing the feasibility of your retirement plan is to find your portfolio's current asset allocation--how your investment assets are apportioned among stocks, bonds, and cash.

If you don't know yours, Morningstar.com's Instant X-Ray tool can help you determine it. Enter each of your holdings into the tool and then click Show Instant X-Ray. (If your current asset allocation is different from what you expect it to be when you're close to retirement, adjust accordingly.)

On the Retirement Income Worksheet http://www.morningstar.com/Cover/income-worksheet.aspx , circle the portfolio mix that most closely matches your own.

Next to the pie chart that matches your asset allocation, circle the number of years that you expect to be retired. Go to the Social Security website for a calculator http://www.ssa.gov/oact/population/longevity.html to help to determine your life expectancy. If you're married, use the female partner's life expectancy because it's longer. If you and/or your spouse are in good health, add a few years or more.

Do You Need a Sure Thing?

How much certainty do you need in your life? Are you a "live for today" sort of person, willing to spend now even if it could result in a shortfall in your income later in life? Or are you someone who would rather spend less during retirement if it means a greater degree of certainty that your money won't run out?

The answer to this question will determine the percentage that you mark in the Certainty of Income column on the Retirement Income Worksheet. If you'd like a high degree of certainty that your money will last throughout your retirement years, circle 85% or 95%. If you're willing to tolerate the possibility of a shortfall in exchange for more spending power early in your retirement years, circle 50%.

How Much Can You Withdraw, and Will That Be Enough?

To help determine your optimal portfolio withdrawal rate given the specifics you've just outlined, find the point on the worksheet where Asset Mix, Certainty of Income, and Years Expected in Retirement intersect. For example, someone with a Moderate Aggressive portfolio seeking an 85% degree of income certainty who expects to be retired 30 years would target a 4.8% withdrawal rate. That's the percentage of your portfolio that you can withdraw per year without a significant risk of running out.

Note that these withdrawal rates assume that your withdrawals will step up annually to keep pace with inflation. They also assume that you'll completely deplete your assets during retirement. Thus, if you're hoping to leave assets to your heirs, you'll need to shrink your withdrawal rate, switch to a more aggressive asset allocation, save more, or plan to retire later.

To help determine whether that withdrawal rate amount is enough to cover your spending needs in retirement, look at the second page of the worksheet. Start by totaling up your investment assets, including taxable accounts as well as any company retirement plan assets.

Next, multiply that amount by the percentage withdrawal amount that you came up with in the preceding step. That's the actual amount that you can withdraw from your portfolio during the first year of retirement. (Divide by 12 to arrive at a monthly withdrawal amount.)

If you're retiring and won't have income from other sources--for example, if you don't have a pension and aren't yet eligible for Social Security--decide whether that income--plus an annual inflation adjustment--is enough to sustain you during your retirement years.

After you've figured out how much help you'll get from your portfolio during retirement, take stock of other expected sources of income during retirement--excluding any withdrawals or income from your investment portfolio. Include income from part-time work, pensions, and any annuity income you're expecting. Also estimate your Social Security benefits using one of these calculators. http://www.ssa.gov/planners/benefitcalculators.htm Add those income amounts together with the income you can safely withdraw from your portfolio. That's the amount of income that you can expect during your first year of retirement.

Finally, adjust your income for taxes. The quick and dirty way to do this is to multiply the income amount by your tax rate. In reality, however, your tax burden may be higher or lower in retirement than it is now..

Making Up for Shortfalls

If it doesn't look like your expected income will cover your spending needs during retirement, spend some time tinkering with the variables. For example, switching to a slightly more aggressive asset-allocation mix could improve your portfolio's return potential (but it could also increase its risk level, so don't go overboard and shift entirely into stocks). And if you're willing to work longer, you could reduce the number of years that you’ll spend in retirement (and, in turn, the need for income from your investment portfolio).

Also bear in mind that even though we've discussed a fixed withdrawal rate in this exercise, you of course will be able to withdraw more or less as circumstances dictate. In fact, a 2008 study from T. Rowe Price showed that the best strategy for retirees who encountered a bear market early on in retirement was to reduce their withdrawal rates. Doing so would help them avoid turning paper portfolio losses into real ones by having to sell out of their long-term investments at an inopportune time.

Quiz 508
There is only one correct answer to each question.

1 What key factors should you take stock of as your evaluate your retirement nest egg?
a. The current asset allocation of your retirement portfolio.
b. The amount of income you can reasonably expect from Social Security, pensions or employer-sponsored retirement plans, and personal savings.
c. All of the above.
2 Based on the retirement income worksheet, what's a safe withdrawal rate for someone with a conservative growth portfolio who expects to be retired for 30 years and is seeking a 95% assurance that he or she won't run out of money during that time?
a. 3.3%
b. 4.0%
c. 4.6%
3 If you find that your portfolio is not on track and you plan to retire in just two years, which should not be an option?
a. Adjusting your asset allocation so that you're holding only stocks.
b. Tweaking your asset allocation modestly, recognizing that adding to equities will increase your return potential but will also boost your portfolio's risk level.
c. Working longer.
4 What is a possible trade-off for obtaining more certainty in your retirement income projections?
a. You may need to lower your withdrawal rate.
b. You may need to retire later than you originally planned.
c. Both of the above.
5 When calculating your income needs in retirement, you should:
a. Only consider your portfolio's income generating ability, to be conservative.
b. Only consider Social Security, annuities, and pensions because investments fluctuate.
c. Consider both sources.
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