Don't bet your retirement on average returns

The Savage Truth

Real life is never average. Especially when it comes to financial planning. Here's the "flaw of averages."

Surely you've heard of the man who drowned walking across the river that had an average depth of 3 feet. That river was 6 inches deep near the banks and 8 feet deep in the center. The "average depth" of 3 feet had absolutely no meaning in reality.

Similarly, in retirement planning, the concept of average returns should be taken with a degree of skepticism. You need a diversified investment portfolio, but don't bet your retirement on average returns.

Planning retirement fund withdrawals involves the "sequence-of-returns" concept -- a subtle form of risk. It's the risk that if you start withdrawing a fixed percentage of your assets every year, and if the market has substantial declines in the early years of your retirement, you will be left with significantly less money to grow in the remaining years. You're likely to run out of money before you run out of time. 

So how do you plan for retirement withdrawals and income opportunities to give you a reasonable chance of making your money last your lifetime? Here are some considerations:


It has long been a standard "rule of thumb" that you could withdraw 4 percent of your retirement funds each year, adjusting the withdrawal for inflation every year, and have a pretty good chance of not outliving your money. Think again. We're in a period of prolonged low interest rates. So in order to make your remaining assets grow enough for this formula to work, you'll have to take on additional investment risk. That could expose your assets to the sequence risk of huge declines in the early years.

Monte Carlo simulations

I'm not suggesting you take your money to a casino. Monte Carlo simulations are a sophisticated method of modeling potential outcomes based on a range of historic interactions between multiple variables. It can be used to give you the probabilities that various investment and withdrawal scenarios will likely meet your retirement goals. This analysis is not produced by a simple online calculator but rather by sophisticated computer programs. It's offered (typically free to clients) by financial planners and mutual fund companies like Fidelity, Vanguard and T. Rowe Price, among others.

Social Security deferral

Nearly two-thirds of seniors rely on Social Security for almost all of their retirement income. But those who have substantial savings should not ignore the opportunities to use Social Security wisely. Deferring a starting date until age 70 (and specifying in writing that you do not want to take benefits even a day before you reach your 70th birthday) can provide an increase of 8 percent in your monthly check for every year you defer between full retirement age and 70 -- a significant increase in benefits over your expected lifetime.

Immediate annuities

You might want to take a part of your retirement funds and purchase an immediate annuity upon retirement. You won't outlive this monthly check -- and that buys some peace of mind. But if inflation returns, the fixed monthly check will not retain its buying power. And if you die sooner than expected, the insurance company keeps the balance of your money, depriving your heirs of the cash.

Longevity annuity

Even if you plan your retirement income stream carefully, you might be forced to dig into principal along the way -- causing you to run out of money in your very old age. A longevity annuity solves that problem. You give the insurance company a lump sum of money now but agree to wait until age 75 or 80 (or later) to start getting lifetime payments. Because of the delay, the payments are significantly larger when they do start.

No one can guarantee future income streams will provide enough to maintain your lifestyle, especially if you need expensive long-term care. But the time to start planning a realistic stream of income is long before you retire. And that's The Savage Truth.

Terry Savage is a registered investment adviser and the author of four best-selling books, including "The Savage Truth on Money." Terry responds to questions on her blog at

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