The "fixed income" strategy relies exclusively on bonds and CDs. An average rate of return of 5% is assumed. Note that this strategy falls behind almost immediately. The first year's withdrawal, after adjusting for inflation, is more than the amount earned. A small dollar amount of securities must be sold in order to fund the full payout. This leaves less remaining to invest in Year 2, resulting in a slightly greater shortfall that year. More securities must be sold to fund the payout. The cycle continues, slowly eating into the principal. Furthermore, the "ending balance" column in Year 10 doesn't tell the full story. After adjusting for 3% annual inflation, the principal's purchasing power is shown to be reduced to an even greater extent (far right column).

Now let's look at the "total return" portfolio consisting of 60% stock funds and 40% bond funds. Returns vary from year to year, but assume they average 9% per year over the entire decade. The first year all goes well, but stocks take a hit in Year 2, pulling the entire portfolio down. Securities must be sold (in such a way as to maintain the 60%-to-40% balance going into Year 3) in order to fund the payout. Briefly, the portfolio is looking worse than the fixed income strategy. What does the retiree do when his stock-oriented portfolio loses money? The first thing to remember is that you are investing for the long-term. Over the long haul, periods of ten years and longer, stocks have consistently produced positive results. Given life expectancies today, most retirees will live for 20-35 years off their portfolios, so a long-term perspective is appropriate.

At the end of the ten years, the stock/bond portfolio is worth $148,820 compared to $90,961 for the fixed income strategy. More importantly, it has maintained its purchasing power ? it's worth $110,736 in constant dollars. Even after adjusting for inflation, the account has 10.7% more purchasing power than it did when the strategy was launched. The important point to note is that the total return approach to investing still allows you to take a full annual withdrawal even in years when the market declined or did not return as much as the withdrawal rate. I used the 60/40 portfolio mix in the example because SMI recommends it for investors with five or less years until retirement assuming you can emotionally accept the risk.


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