It's Time to Revise the Retirement Plan

If you are nearing retirement and have lost asubstantial amount of money in your retirementplan(s) because of the volatile market,you are not alone—many of your colleagues have aswell. Is there reason for concern? Obviously, theanswer is yes, especially if you've capitulated, convertedall your assets to cash, or have nodefinitive long-range financial plan. Letme illustrate by way of a case study.

CASE IN POINT

Dr. David Drummond and hisspouse Kathryn live in Southern Michigan.David practices family medicineand Kathryn is a registered nurse at asmall community hospital. David is 59years old, Kathryn is 61 years old, andthey had planned to retire within thenext couple of years. At the beginning of2000, they had combined retirementassets of almost $4 million. Earlier thisyear in mid-September they liquidatedtheir entire investment portfolios andplaced the proceeds in a money marketaccount yielding essentially nothing andhave done nothing since that time.

When they liquidated their accounts,the value had plummeted some 40% to approximately$2.4 million from the beginning of 2000. Byway of comparison, from January 1, 2000, throughSeptember 30, 2002, the S&P 500 was down42.5%.The S&P 500 is nothing more than a broadindex made up of the nation's 500 largest US corporations.Actually, since David and Kathryn'sportfolios were entirely invested in equities, theydid not underperform the overall equities market.

The first question you might ask is, if they areonly a few years from retirement, why were theyinvested so aggressively in equities, which lost nearly40% of their value in an 18-month period? Formany this was not unusual. Everyonewas enjoying the "wild ride" up, but fewtook the time to assess the risk inherentwith investing in the stock market.

APPROPRIATE STRATEGY

As you near retirement, regardless ofthe performance of the equity's markets,you should adopt a more conservativeinvestment posture, which might call fora balanced investment strategy comprisedof a 40%/60% distribution offixed-income and equity investments,respectively. The fixed-income portionof the portfolio would have acted as aportfolio buffer in this turbulent market.In fact, as interest rates have declined inrecent years, bonds in general haveyielded a very respectable return. Forinstance, during the same time periodthat the S&P 500 lost 42.5%, the LehmanBrother's Aggregate Bond Index was up31.4%. On an annualized basis, the S&P 500 wasdown 18.2% while the Lehman Brother's BondIndex was up 10.4%. By way of comparison, hadtheir portfolio been invested 50% in the S&P 500and 50% in the Lehman Brother's Aggregate BondIndex, the total loss would have been a mere 5.5%.

You may wonder what effect this will have onDavid and Kathryn's annual income during retirement.To illustrate the impact on retirementincome, I have made the following assumptions:

• Annual rate of inflation: 3.5%,
• Annual investment rate of return: 7% (tax-deferred), and
• Retirement time horizon: 25 years.

If they were to retire today, and one of themlives 25 years in retirement, a $1 million losswould translate into a reduction of $60,000annually in retirement income each year duringretirement, assuming that income is adjusted by3.5% annually during retirement and their portfoliosearn 7% tax-deferred.

Obviously, you can see that this 40% loss intheir investment portfolio will have a dramaticimpact on their annual retirement income. Youwill notice that I have assumed a 7% taxdeferredannualized rate of return. You will notgenerate this type of long-term return witheverything parked in a money market portfolio.By the same token, it would prove challenging togenerate this type of return in this current turbulentmarket environment, but not impossible.

What becomes crucial here is not only for Davidand Kathryn to temper their expectations relative toretirement income, but to also develop and implementa long-term investment strategy. This strategyshould mitigate market risk and preserve capitalwhile at the same time producing a long-term rateof return sufficient to cautiously grow their assetsand generate sufficient income that will last for a25-year retirement time horizon.

Thomas R. Kosky and his partner, Harris L.

Kerker, are principals of the Asset Planning

Group in Miami, Fla. Mr. Kosky teaches corporate

finance in the Saturday Executive and

Health Care Executive MBA Programs at the

University of Miami and welcomes questions

or comments at 800-953-5508. For more

information, visit www.assetplanning.net.