Will I be able to retire ever? Answers to our clients' #1 question!


Our clients are divided between those who are at least 65 and already retired (30%) and those clients aged 35-65 for whom retirement seems like an ever receding mirage. In this commentary, we will concentrate on the mechanism that we use to implement a client's retirement income strategy, review how this strategy has performed since January 2000, and review the lessons learned:

Relative Investment Risk

You don't get return without risk. From highest to lowest (assigning extra risk to leveraged, illiquid (locked-up) or non-dollar investments,) the available asset classes are:

Risk Assets

  • Hedge Funds
  • Private Equity
  • Limited Partnerships
  • Directly held Real Estate
  • Commodities
  • International Emerging Market Stocks
  • International Developed Market Stocks
  • US Small Cap Stocks
  • US Mid Cap Stocks
  • US Large Cap Stocks
  • International Bonds

Fixed Income

  • US Corporate Bonds
  • US Municipal Bonds
  • US Long Dated Government Bonds
  • US Intermediate Term Bonds

Near Cash

  • US Money Markets (Bank CD's, Commercial Paper)
  • US Treasury Bills
  • Cash

Based on historic (since 1945) averages, we'd expect Risk Assets to return about 8%, Fixed Income assets about 3.5%, Near Cash assets about 0.2%/year. A retiree could hold 100% of assets in Near Cash, but the portfolio would eventually run down to zero, possibly while the retiree was still alive. Alternatively, a retiree could choose 100% of the fixed income allocation, but if inflation picks up, then the purchasing power of the portfolio might not hold up. Or a client could choose 100% of the Risk Assets portfolio, but might lose much sleep as those assets classes have become increasingly volatile - nothing about the last decade has been "average."

The 3-Bucket Retirement Income Strategy

For decades, wealth advisors including ourselves have divided their retired clients' assets into three "buckets." Typically, 70% of the client's wealth is in the "Risk Assets" bucket, 25% is in "Fixed Income," and 5% is in "Near Cash." As we have shown in our cartoon, a tap attached to the "Near Cash" distributes 4% of the total portfolio to the client at the rate of 0.3333%/month (the client's "Allowance.") Clients may receive additional income from Social Security, pension plans and annuities. Generally speaking, we find that if our clients know what their monthly income will be, they adapt their spending accordingly. We have some clients drawing as much as 6% of their portfolios, but especially in the current environment, we encourage our clients to target 4%.

Obviously if the "Near Cash" portfolio is set at 5% of overall assets and we're drawing 4%/year, we would drain that bucket in just over a year. However, the "rain" of investment returns continues to fall into the "Risk Asset" and "Fixed Income" buckets. Once or twice a year we rebalance the client's allocation among the respective buckets, which generally means "pouring" excess assets from the "Risk" bucket into the "Fixed Income" bucket and from "Fixed Income" to "Near Cash." We had two major "droughts" in the last decade, 2000-2002 and 2008-9, which meant that sometimes no funds transferred from the "Risk Bucket" for a year or even two years. But the reserve in the "Fixed Income" bucket kept the cash flowing.

Does the strategy work in the "Worst Case Scenario?"

No doubt about it, the environment for US stocks since January 2000 has been toxic, the worst since 1966-1980, and before that 1929-1942. We put together a strategy that replicates the portfolio of our "average" client, with a mix of mutual funds and ETF's. DISCLAIMER ALERT: none of our clients has exactly this portfolio; actual client returns were better or worse. However, the model is "good enough" to explain the concept.

We created a hypothetical $1 million portfolio that was invested January 1st, 2000, or exactly 12 weeks before the S&P 500 set an all-time March 24th, 2000, comprised of:

As much as possible, we used mutual funds or ETF's to capture real returns net of manager fees. We use the CRB index as we don't have a pure commodity fund or ETF for the whole period. Generally we use individual stocks or an array of mutual funds, for our US domestic exposure; to simplify, we used the Russell 3000 ETF. We used 1 month Treasury bills as a proxy for money market returns.

Once again we are reminded how badly US stock underperformed other assets classes over the last 11 years - even T-bills did better! But don't forget - the Russell 3000 returned 302.1% or 14.9%/year in the previous decade. For the last 21 years, the average annual return of the Russell 3000 was 6.2% and from the inception of the index in 1978, 8.3%/year. The all-stars of the last decade, Emerging Markets and US Corporate Bonds, are unlikely to be the all-stars of the next decade.

The Model Portfolio

We extracted the quarterly returns of these investments and created a hypothetical $1 million portfolio distributing 4%/year at the rate of 1% or $10K/quarter. We also charged our maximum investment advisory fee of 0.25%/quarter to the portfolio. We rebalance our portfolios at least once, usually twice/year. For the model, these rebalances occurred as of March 31st and September 30th of each year. This chart shows the composition of the portfolio as markets fluctuated over the last eleven years:

As first take, the strategy looks disastrous! Thanks to the bear markets of 2000-2 and 2008-9, the portfolio is worth $220K less than inception. But on further inspection, we note that the portfolio recovered to its inception value 5 years after the first bear market. We expect the market (and this portfolio) to regain a new high around 5 years after the second bear market.

What matters most to the client, however, is the value of the assets in the "Near Cash" and "Fixed Income" buckets, which stayed relatively constant between $200-$300K. The beautiful component of this strategy is that no matter how much the "Risk Assets" gyrate with current events, there is always plenty of money to pay out the client's "Allowance." In fact, if the Russell 3000 had returned the historic average of 8%/year return over the last 11 years, the portfolio would currently be worth $1.1 million!

Lessons for retirement planning

  1. This strategy assumes that the clients' goal is to leave the bulk of the portfolio to their estate. In fact, we can achieve a higher draw rate by converting part or the entire portfolio to an annuity, though obviously no residual value for an estate.
  2. When the news is the worst, the last thing you should do is sell stocks. Millions of average Americans liquidated their stock investments at each market low - they will never be able to retire. Europe looked grim last summer, but from the October 3rd low last fall, the S&P 500 is up 20.8%!
  3. A portfolio should hold about a year's distribution in "Near Cash" - virtually no return, but also no doubt whether the funds will be available as scheduled.
  4. A portfolio should be about 20-30% in fixed income assets, which will return a little more than inflation, but will enable you to ride out 5 years of bad returns in stock and other risky markets
  5. The values of "Risk Assets" are becoming ever more correlated - you can no longer get true diversification by buying, for example, emerging market stocks. However, certain sectors surge relative to others over time (for example, non-US stocks when the dollar is falling.) If you periodically rebalance, scaling back on sectors that have well in favor of sectors that have done poorly, you are constantly selling high and buying low.

Am I on the "glide path" to retirement?

For our clients who are ready retired, we say "Turn off CNBC and relax. Just about everything short of a nuclear weapons exchange that could possible go wrong, has gone wrong since 2000. However, your 'allowance' still gets paid every month."

For our clients 40-60 years old, for whom retirement is still in the future, you will get there eventually, but you must stick to the plan. Our "quick and dirty" analysis of a client's minimum retirement income is 100% of their current after tax income (not 70%, as many financial planning programs estimate.) We back out estimated Social Security payments and the value of any pension benefits. For example a couple currently earns $100K after tax, will receive $30K in Social Security and $10K in pension benefits, leaving $60K/year need. We tell these clients to target a 6% draw rate initially, which requires a nest egg of $1 million. If that goal can be achieved, then target the 4% draw rate, which would be nest egg of $1.5 million.

If that seems impossible, just consider our observation is that "the first $500K is always the hardest; thereafter compounding takes over." Max out your 401K contributions, aggressively pay down debt, expect to retire closer to 70 than 65, which will allow for an extra 5 years of savings, take Social Security at 70 for the higher payout, not at 65.

Mostly importantly, make sure that your asset allocations are moving towards the retirement income targets by the time you retire. Within your accounts, "Risk Assets" should be allocated to retirement accounts, while "Near Cash" and "Fixed Income" should be allocated to taxable accounts (for quick access in an emergency.)


You can beat a dog only so long before he no longer cares. You can beat investors only so long about 'bad news out of Europe' before they no longer care. We commented late last year that "the situation in Europe developed over the last 30 years. It's the Europeans' problem to fix, and it won't be fixed overnight. Meanwhile, the United States has its own problems, but as long as stock valuations remain cheap and interest rates remain low, we are buyers of stocks."

We were handsomely rewarded in Q4 2011 for going fully invested in September 2011, and are rewarded so far this year with US stocks up 4.8% in the S&P 500 (our forecast is 12% for the whole year.) International markets had an abysmal year in 2011, but are starting off the year with gains averaging around 6% and +10% gains in emerging markets.

Operational Activities

  1. This is the last report that combines clients' portfolio performance reports and our monthly commentary. The portfolio reports are always complete by the second business day of the month, while the commentary can be delayed (as we see this month) by any number of factors. Separating the two will give our clients more timely data.
  2. For your income tax filings: by the end of February, brokerage 1099 statements will be available at www.Fidelity.com. You can download those statements as PDF's and forward to your accountant. If you have already given us your accountant's contact information, we will forward the 1099's for you.
  3. K-1's should be available for any stock designated an LP or "limited partnership" from February 15th-April 1st. You can download those directly from individual company websites, but we will download for all our clients, forward to you and to your accountant.
  4. In 2011, we substantially upgraded the technology we use to manage our clients' financial affairs and trade their portfolios more efficiently. We already see the benefit in these upgrades in that we can now "pro-act" rather than "re-act" on behalf of our clients. For example, we now remind our clients about annual stock gifts to charity rather than wait for the client to remind us.
  5. Our new website www.HeronFinancialGroup.com is in beta, which is to say that the overall design is in place, but most of the links don't work. We hope to have that work complete by the end of the first quarter.
  6. We are in the process of selecting a vendor to upgrade our client reporting systems. The selection process will occur in Q2 2012, and roll out over the next six months. Our goal is to customize reports by client, so each client gets exactly the information desired. Chief complaint about our current reports is that the type font is too small - we will be sure to address that. We also hope to deliver the reports to a "secure vault" accessible by ourselves, our clients and other professionals such as accountants that work for our clients.
  7. We intend to put out another "client satisfaction" survey in April. This will be a web-based survey though paper versions are available on demand. We are particularly interested in "negative feedback" as often our perception of problem areas is different than our clients' perception of problem areas.