Wednesday, April 16, 2008

Portfolio Growth after Retirement

Russell Investments reports that up to 60% of portfolio growth may come after retirement (the web page with this article has disappeared since the time of writing). This seems surprising at first. We tend to think that the portfolio growth phase ends when we retire.

Of course, it depends on what they really mean by this statistic. They say that money available during retirement consists of about 10% money saved while working, 30% investment growth before retirement, and 60% investment growth after retirement.

So, they aren’t saying that your retirement nest egg will necessarily continue to grow substantially after you retire (because of withdrawals). What they are looking at is the total of your portfolio plus all the withdrawals during retirement.

The fact that 60% of growth comes after retirement isn’t so surprising if you think about the way that portfolios grow. A portfolio that grows at 10% per year will double about every 7 years, and 60% of the growth is in the past 10 years. In his 1998 annual report, Berkshire Hathaway’s Chairman Warren Buffett could have reported that 60% of his company’s total growth had come in the previous 3 years. With this in mind, it’s surprising that there isn’t more growth over a 25-year retirement.

It’s the withdrawals during retirement that cut into future investment returns. Still, it doesn’t take a very high yearly return to get up to the 60% figure.

Suppose that a retiree withdraws 1/25th of his money in the first year of retirement, 1/24th in the second year, and all the way to withdrawing all that remains in the 25th year. For 60% of his money to come from post-retirement returns, he needs an average return of 6.7%.

I’m certainly hoping to make more than 6.7% per year on my money after I turn 65, at least for the first 15 years or so. At any given time, I intend to have 3 years worth of living expenses in fixed income investments and the rest in the stock market.

This means that more than half of my money will be in stocks into my 80’s (if I make it that long). Over such a long period of time, I expect my mix of stock and fixed income investments to average more than 6.7% per year. But, there are no guarantees when it comes to the stock market.

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