Transcript General

Managing Your Money
During Retirement
Maria Crawford Scott
Former Editor, AAII Journal
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The Retirement Savings Dilemma:
Competing Goals
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Ensuring your savings last throughout your
lifetime
Withdrawing as much as possible each year
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Discussion Topics
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Your Withdrawal Rate: How to determine the
amount of money you can safely withdraw each
year. The key to your portfolio’s long-term survival.
Asset Allocation: What is a prudent approach?
Maintaining Your Portfolio: Steps you can take to
ensure you remain on course, especially during
challenging times.
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One Popular Withdrawal Approach:
The Downside
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Each year, withdraw only the income
generated from your portfolio.
Downside: Encourages heavy allocation to
high-income but low-growth investments
such as bonds.
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Another Possible Withdrawal
Approach: The Downside

Each year, withdraw only the real rate of
return from your portfolio.
Downside: Does not produce a stable
annual source of income.
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The “Withdrawal Rate” Approach
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Create your own immediate annuity based on your total
investment assets.
First, determine a “first-year withdrawal rate” (a percentage of
your portfolio). Use your life expectancy as the time period
and the estimated real return (return AFTER inflation) for your
portfolio over your life expectancy as the assumed return rate.
Second, translate the first-year withdrawal rate into a dollar
amount, which is your first-year “income”—the actual dollar
amount that you can withdraw from the portfolio the first year.
The next year, you are allowed to withdraw your prior-year
dollar amount, but increased by the rate of inflation.
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An Example
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$1 million portfolio
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4% first-year withdrawal rate
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3% inflation
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First-year withdrawal amount: $40,000
(4% of $1 million)
Second-yr. withdrawal amount: $41,200
[$40,000 + (3% x $40,000)]
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Withdrawal Rate Approach
Clarified
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The withdrawal “rate” is a percentage that applies only to
your first-year withdrawal.
The withdrawal amount is a “gross” figure that, along
with any other sources of income, is used to pay annual
living expenses, including taxes.
The withdrawal amount does not take into consideration
taxes that may be due based on the source of the
withdrawal.
The withdrawal rate has nothing to do with “required”
withdrawals from retirement accounts.
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The Withdrawal Rate Approach
Advantage
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The point of this approach is to separate
your asset allocation decision from your
immediate withdrawal needs so that they
do not drive your allocation decision.
Encourages you to invest for the long
term, since the withdrawal rate does NOT
depend on any income component.
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Adapting the Withdrawal Rate
Approach to the Real World
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Annuity tables assume unvarying return rates each year,
but in the real world, your return rates will vary
significantly year-to-year.
For portfolios in which there are NO additions and NO
withdrawals, the return sequence has NO IMPACT on
the ending value.
For portfolios in which there ARE withdrawals each year,
return sequences matter: For two portfolios with the
SAME long-term average return, the one with higher
returns at the beginning will have a higher end value
than the one with higher returns toward the end.
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Adapting the Withdrawal Rate
Approach to the Real World (con’t)
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Base your withdrawal rate on studies of portfolio
“success” (or “survival”) rates.
The “success” rate is the percentage of times a
portfolio is able to sustain the given payout over
the entire time period without running out of
assets prematurely.
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Portfolio Success Rates: Updated
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Shortfall Risk (Runout Percentage) at Various Withdrawal Rates
Source: “Guidelines for Withdrawal Rates and Portfolio Safety During
Retirement,” by John J. Spitzer, Jeffrey C. Streiter and Sandeep Singh,
Journal of Financial Planning, October 2007.
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The Key to Portfolio Survival
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Use a realistic withdrawal rate: not more than
4% of the initial portfolio value. In subsequent
years the annual dollar amount can be
increased by your assumed inflation rate.
Maintain a prudent asset allocation.
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What Is a “Prudent” Asset
Allocation?
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Based on your personal investment profile: your
return needs (income vs. growth), your tolerance
for risk and your time horizon.
No single asset class will match all of your
requirements.
Diversifying your portfolio among the major
market segments allows you to meet various
needs while reducing various risks.
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Major Market Segments
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Stocks: Higher growth potential, lower and
unsteady income, ability to outpace inflation,
liquid markets but high risk of selling at a loss
Bonds: Low growth potential, steadier income,
unable to outpace inflation, liquid markets but
high risk of selling at a loss
Cash: No growth, unable to outpace inflation,
use to reduce liquidity risk of total portfolio
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Stocks, Bonds and Cash:
1926 Through 2012
Total
Annual
Average
(%)
Large Co. Stocks
9.8
Long-Term Gov’t Bonds 5.7
T-Bills
3.5
Inflation
3.0
After
Inflation
(%)
6.7
2.6
0.5
na
Average
Growth
(%)
5.6
0.4
0.0
na
Source: “Stocks, Bonds, Bills and Inflation—2013 Yearbook,” Ibbotson Associates,
Chicago.
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Highest and Lowest Returns
(1926 through 2012)
Annual Returns (%)
Large Co. Stocks
Long-Term Gov’t Bonds
Balanced (50/50 Stocks/Bonds)
T-Bills
Inflation
5-Year Rolling Returns (%)
Large Co. Stocks
Long-Term Gov’t Bonds
Balanced (50/50 Stocks/Bonds)
T-Bills
Inflation
Highest
Lowest
53.9 (1933)
40.3 (1982)
34.7 (1995)
14.7 (1981)
18.1 (1946)
-43.3 (1931)
-14.9 (2009)
-24.7 (1931)
0.0 (1938)
-10.3 (1932)
28.6 (1995-99)
21.6 (1982-86)
20.9 (1982-86)
11.1 (1979-83)
10.0 (1977-81)
-12.4 (1928-32)
-2.1 (1965-69)
-2.8 (1928-32)
0.1 (1938-42)
-5.4 (1928-32)
Source: “Stocks, Bonds, Bills and Inflation—2013 Yearbook,” Ibbotson Associates, Chicago.
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Highest and Lowest Returns
(1926 through 2012) (cont’d)
10-Year Rolling Returns (%)
Large Co. Stocks
Long-Term Gov’t Bonds
Balanced (50/50 Stocks/Bonds)
T-Bills
Inflation
20-Year Rolling Returns (%)
Large Co. Stocks
Long-Term Gov’t Bonds
Balanced (50/50 Stocks/Bonds)
T-Bills
Inflation
Highest
Lowest
20.0 (1949-58)
15.5 (1982-91)
17.0 (1982-91)
9.2 (1978-87)
8.7 (1973-82)
-1.4 (1999-08)
-0.1 (1950-59)
2.0 (1965-74)
0.1 (1933-42)
-2.6 (1926-35)
17.9 (1980-99)
12.1 (1982-01)
14.7 (1979-98)
7.7 (1972-91)
6.4 (1966-85)
3.1 (1929-48)
0.7 (1950-69)
4.6 (1929-48)
0.4 (1931-50)
0.1 (1926-45)
Source: “Stocks, Bonds, Bills and Inflation—2013 Yearbook,” Ibbotson Associates, Chicago.
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One Starting Point:
Cash for Liquidity
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Provides liquidity, particularly during extreme market
conditions when you do not want to sell any stock
holdings.
Helps protect stock holdings during bad times—provides
a cushion so you are less likely to panic and sell at a
market low, the worst possible time.
Recommendations: 3 to 5 years’ living expenses.
A 4% withdrawal rate, combined with cash totaling 5
years, implies at least a 20% cash component.
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Stocks for Portfolio Survival Over
Long-Term Withdrawal Periods
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The longer your payout period, the greater the stock
exposure required to ensure a portfolio’s survival. For
30-year time horizons you need roughly a 50% stock
commitment to ensure portfolio survival if you use a 4%
initial withdrawal rate.
Stock portfolios must be diversified.
One suggested rule of thumb:
120 – your age = stock %
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Bonds for Stability and Yield
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Your bond allocation depends on your risk
tolerance (stock allocation)—whatever
percentage remains after allocating to
cash and stocks.
Keep maturities short- to medium-term (5
to 7 years) to reduce downside risk.
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Asset Allocation Among
the Market Segments
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The least volatile segment should be used as
the core (at least 50% of that asset class).
More volatile segments can be added to varying
degrees, but at least 10% is needed to have a
meaningful diversification effect.
Make sure you understand the risks of the noncore segments.
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One Approach to Allocating Among
Market Segments
Stock Market Segment
Large Co.
Core: 80% to 50%
Small Co.
Non-Core: 10% to 40%
International
Non-Core: 10% to 40%
Bond Market Segment
High-Quality
Core: 80% to 50%
High-Yield
Non-Core 10% to 40%
International
Non-Core: 10% to 40%
The percentages range from conservative to aggressive and are based on the
concept of effective diversification within the asset classes, with variations based on
your investor profile. However, final allocation decisions should be based on a
thorough understanding of the investment categories. Never invest in a segment if
you don’t understand it or are uncomfortable with the risks.
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Maintaining Your Portfolio
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Portfolio Management Rules
Inflation Rules
Withdrawal Rules
Capital Preservation Rules
Midcourse Adjustments
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Portfolio Management Rules
Portfolio management rules add only
minimal benefits to the withdrawal rate:
1)
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In a year when performance causes an
asset class to become overweighted, sell
excess and invest in cash.
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Portfolio Management Rules
(cont’d)
2)
Withdrawals each year are funded in the
following order: Stock overweightings; fixedincome overweightings; cash; withdrawals
from fixed income; withdrawals from stock
segments based on prior year’s performance.
3)
No withdrawals from any stock segment
following a year in which it had negative
returns if cash or fixed-income assets can fund
the required withdrawal.
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Inflation Rules
Inflation Rules add slight benefits to the
withdrawal rate:
1)
Maximum annual inflation increase is
6%.
2)
There is no “make-up” for a capped year.
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Withdrawal Rules:
Modest Benefits
Withdrawal Rules add modest benefits to
the withdrawal rate:
1)
No increase in withdrawal amount for
inflation if prior year’s investment return
is negative.
2)
No “make-up” for a missed year.
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Capital Preservation Rules
Capital Preservation Rules do benefit the withdrawal rate:
1)
If current year’s withdrawal rate rises more than 20%
above the initial withdrawal rate, then the current
year’s withdrawal is reduced by 10%.
2)
Decreased withdrawal rate becomes basis for
determining next year’s withdrawal amount.
3)
Rule expires 15 years before maximum planning age.
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Capital Preservation Rules (Cont’d)
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Drawback: Lost purchasing power each
time rule is triggered.
“Prosperity rule” (increases the withdrawal
rate when current withdrawal rate is 20%
below the initial withdrawal rate) can be
applied; drops the benefits to the
withdrawal rate by about 0.5%.
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Capital Preservation Rule Example
Initial Portfolio Value: $1 million; First-Year Spending Rate: 5.5%; Trigger Rate: 6.1%
Year
1
2
3
4
5
6
7
8
9
10
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Annual
Actual
Spending Annual
Amount Return
($)
(%)
55,000
8.3
56,650
-3.1
56,650
14.0
58,350
7.6
60,100
-2.3
60,100
4.0
61,903
9.2
63,760
11.5
65,673
-5.4
65,673
-11.3
65,673
20.6
Savings at
Year-End
($)
1,022,963
936,840
1,003,417
1,016,420
934,802
909,691
925,360
960,684
847,128
693,541
757,209
50% Stock/50% Bond Portfolio
New
New
Current
New
Current
New
Current
Spending Spending Savings Spending Spending Savings Spending
Rate
Amount Year-End
Rate
Amount Year-End
Rate
(%)
($)
($)
(%)
($)
($)
(%)
5.5%
5.5%
6.0%
5.8%
5.9%
6.4%
54,090 915,941
5.8%
6.8%
55,713 938,939
6.1%
50,141
945,020
5.5%
6.9%
51,646
996,113
5.5%
6.8%
53,195
892,471
5.3%
7.8%
53,195
744,858
6.0%
9.5%
53,195
834,145
7.1%
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Decision Rules and the
Withdrawal Rate
No Decision Rules
Portfolio w/50% Stock
Portfolio w/80% Stock
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90% Success Rate
Max
Amt
Initial
of
W/D Rate Increase
(%)
(%)
95% Success Rate
Max
Amt
Initial
of
W/D Rate Increase
(%)
(%)
3.6
3.6
na
na
3.3
3.0
na
na
Portfolio Management Rules
Portfolio w/50% Stock
Portfolio w/80% Stock
3.6
3.6
0
0
3.3
3.2
0
7
Inflation Rules
Portfolio w/50% Stock
Portfolio w/80% Stock
4.1
4.0
14
11
3.7
3.4
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13
Withdrawal Rules
Portfolio w/50% Stock
Portfolio w/80% Stock
4.3
4.4
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22
3.9
3.9
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(Continued on next slide)
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Decision Rules and the
Withdrawal Rate (Cont’d)
All Three Rules
Portfolio w/50% Stock
Portfolio w/80% Stock
Add Cap Preserve Rule*
Portfolio w/50% Stock
Portfolio w/80% Stock
90% Success Rate
Max
Amt
Initial
of
W/D Rate Increase
(%)
(%)
95% Success Rate
Max
Amt
Initial
of
W/D Rate Increase
(%)
(%)
4.7
4.8
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4.3
4.3
30
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5.1
6.3
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75
4.8
6.2
45
106
Assumes a 40-year horizon.
*Inflation Rule was dropped for this scenario.
Source: “Decision Rules and Maximum Initial Withdrawal Rates,” by Jonathan T. Guyton and
William J. Klinger, Journal of Financial Planning, March 2006.
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Portfolio Maintenance: The
Midcourse Adjustment Strategy
Every 5 years, re-evaluate and re-adjust withdrawal amounts based on
size of portfolio and shorter time horizon. The results of the study
indicated this strategy was:
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Less likely to run out of money early in retirement.
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More likely to provide larger total withdrawals over the retirement
span.
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Not designed to provide a large estate.
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Likely to produce more variability in withdrawal amounts, with the
possibility of some being much lower than average.
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Midcourse Adjustment Study
Strategy comparison: Withdrawal amounts for 5% shortfall risk and a
50/50 stock/bond allocation
Fixed
Withdrawal
Strategy*
Mid-Course
Correction
Strategy**
Maximum Sustainable Withdrawal Rate (%)
3.8
17.17
Average Withdrawal Rate (%)
3.8
8.4
Shortfall (% out of 10,000 sequences)
4.5
4.8
Earliest Runout Year
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Balance Remaining ($; start amount: $100)
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* Fixed Strategy: Fixed withdrawal and fixed allocation (50/50 stocks/bonds).
** Mid-Course Correction: Revised withdrawal rate every 5 years and fixed allocation (50/50
stocks/bonds).
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Source: “Retirement Withdrawals: An Analysis of the Benefits of Periodic ‘Midcourse’ Adjustments,” by
John J. Spitzer, Financial Services Review 17 (2008).
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Maximum Withdrawal Rates and
Corresponding Stock Allocations
Longevity
(Years)
5
10
15
20
25
30
35
5% Shortfall Risk
Stock
Max
Alloc.*
W/D
(%)
(%)
20
18.6
20
9.5
25
6.6
35
5.3
35
4.4
30
3.9
40
3.5
10% Shortfall Risk
Stock
Max
Alloc.*
W/D
(%)
(%)
25
19.3
35
10.1
35
7.1
40
5.7
55
4.9
50
4.4
45
4.0
*Remainder is in bonds
Source: “Retirement Withdrawals: An Analysis of the Benefits of Periodic ‘Midcourse’
Adjustments,” by John J. Spitzer, Financial Services Review 17 (2008).
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Strategy Comparison: Withdrawal
Amounts for 5% Shortfall Risk
Max Sustain W/D Rate (%)
Avg Withdrawal Rate (%)
Shortfall (% of 10,000)
Earliest Runout Year
Balance ($; Start: $100)
Fixed
Strategy*
3.8
3.8
4.5
14
206
Mid-Course
Correction
Strategy**
17.2
8.4
4.8
29
23
Mid-Course/
Variable
Allocation
Strategy***
11.3
6.7
5.2
29
12
* Fixed Strategy: Fixed withdrawal and fixed allocation (50/50 stocks/bonds).
** Mid-Course Correction: Revised withdrawal rate every 5 years and fixed allocation (50/50
stocks/bonds).
*** Mid-Course/Variable: Revised withdrawal rate and variable allocation (decreasing stocks).
Source: “Retirement Withdrawals: An Analysis of the Benefits of Periodic ‘Midcourse’
Adjustments,” by John J. Spitzer, Financial Services Review 17 (2008).
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Live Long and Live Well:
A Portfolio Survival Guide
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NUMBER 1: Use a ‘withdrawal rate’ approach to
separate your asset allocation decision from your
immediate withdrawal needs, and to encourage you to
invest for the long term.
NUMBER 2: Use a realistic withdrawal rate—not more
than 4% of the initial portfolio value. In subsequent
years, the annual dollar amount can be increased by
your assumed inflation rate.
NUMBER 3: Asset allocation helps you reduce the risk,
over the long term, of unknown (in advance) adverse
conditions. Make sure your portfolios are well-diversified
among the major market segments, and do NOT make
any major bets on any one market segment or any single
style of investing.
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Live Long and Live Well:
A Portfolio Survival Guide
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NUMBER 4: Use your cash allocation as a life preserver
for extreme market conditions—maintain a cash
exposure of 3 to 5 years’ living expenses for liquidity.
And if you have a longer-term horizon, maintain at least
a 50% exposure to stocks to provide growth and to
protect the long-term purchasing power of your future
withdrawals.
NUMBER 5: Use rules regarding annual withdrawal
amount increases and decreases to help maintain your
portfolio—and ensure that you stay on course.
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AAII Journal Resources
ARTICLES (all are available at the AAII website: www.aaii.com)

“A Key to a Lasting Retirement Portfolio,” by John Sweeney, April 2013.

“Finding the Right Withdrawal Rate: One Key to Portfolio Sustainability,” by Maria Crawford Scott, July 2012.

“Portfolio Rebalancing: Diversification, Risk Control and Withdrawals,” by Charles Rotblut, March 2012.

“Getting Through Difficult Markets,” by Julie Jason, November 2011.

“Retirement Spending on Planet Vulcan: Longevity Risk and Withdrawal Rates,” by Moshe Milevsky and Huaxiong Huang, September
2011
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“Repairing the Damage to Assure the Flow,” by Christine Fahlund, February 2009
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“Will Your Savings Last? What the Withdrawal Rate Studies Show,” by William Reichenstein, July 2008

“Optimizing Your Retirement Income: What Works Best and Why,” by Christine Fahlund, August 2008

“Invest or Delay? Strategies for Taking Social Security Benefits,” by Christine Fahlund, February 2007
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“Withdrawal Strategies to Make Your Nest Egg Last Longer,” by William Reichenstein, November 2006

“Tax-Efficient Investing: Picking the Right Pocket for Your Assets,” by William Reichenstein, November 2005

“Withdrawal Rules: Squeezing More From Your Retirement Portfolio,” by Jonathan Guyton, August 2005

“Allocation During Retirement: Adding Annuities to the Mix,” by William Reichenstein, November 2003

“Bear Market Strategies: Watch the Spending, Hold the Stocks,” by T. Rowe Price Associates, May 2003

“Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable,” by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz,
February 1998
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