The phone conversation with a harried Peter Lynch was brief. If owning a 100 percent stocks portfolio that you withdrew a bond-like 7 percent income from didn't work, he said, surely there was some withdrawal rate where it WOULD work.

Interesting idea.. and you'll see the results of more bench testing in a minute.

The conversation was the end result of four days of trying to reach him to comment on my recent columns ( Sunday, October 1 and Tuesday, October 3 ) about how his All Stocks strategy didn't work when subjected to real world bench testing. Worse, that it could lead some retired investors directly to the poor house.

In case you missed the column, here's the issue--- one that affects the great majority of retirees. Can you withdraw principal as well as dividends from a stock portfolio and not eventually exhaust your nest egg?

Mr. Lynch, writing in Worth magazine, said you could invest $100,000 in dividend growing stocks and withdraw $7,000 a year and still have $345,000 at the end of 20 years. Magic. In the worst case, he wrote, you would have $185,000.

Real world testing produces very different results. Testing 20 year investment periods from 1960 or 1965 to the present, we found that a $7,000 a year withdrawal program had about a 50 percent chance of losing principal and a small chance of leaving the investor stone broke.

In fact, how the strategy works is HIGHLY sensitive to how much principal you withdraw in addition to dividends.

Suppose, for instance, you had invested $100,000 in the typical growth mutual fund--- funds that emphasize capital gains. The long term result would depend very much on WHEN you made the investment, whatever your withdrawal rate. But the larger the withdrawal, the greater the danger to your financial health. At $7,500 a year, for instance, withdrawals would have led to being broke in 6 of the 11 twenty year periods between 1965 and 1994. Only when the withdrawal rate is reduced to $4,000 a year (4 percent of original investment) can you be certain that you'll at least retain your original investment over 20 years. The table shows the results.

Volatile Growth Stock Funds Aren't Suitable For Systematic Withdrawal Plans

Withdraw Amount Lowest Result Median Highest
$7,500/yr $0 (6 times) $0 (1x) $695,227
$7,000 $0 (3 times) $19,092 $737,297
$6,500 $0 (2 times) $64,021 $779,359
$6,000 $0 (1 x) $108,969 $821,429
$5,500 $18,698 $149,658 $863,500
$5,000 $51,348 $180,365 $905,561
$4,500 $84,007 $206,152 $947,631
$4,000 $116,666 $241,797 $989,201
Source: Towers Data Systems

Fortunately, results improve substantially when you invest in less volatile stocks that produce more dividend income--- such as growth and income mutual funds or the Standard and Poor's 500 index. In that case, simply reducing the annual withdrawal from $7,000 to $6,000 eliminates the potential for losing principal over a twenty year period.

Results of Different Withdrawal Programs from the Lipper Growth and Income Fund Index ( 1965-1994)

Withdrawal Amount Worst Year Result Median Best Year Result
$7,500 $12,675 $156,885 $786,478
$7,000 $53,074 $195,228 $829,215
$6,500 $98,468 $242,564 $871,945
$6,000 $133,869 $289,901 $914,682
$5,500 $174,272 $337,248 $957,422
$5,000 $214,666 $384,578 $1,000,149
Source: Towers Data Systems

A similar exercise with the Standard and Poors 500 Index shows similar results because there is very little variation in annual returns for the Standard and Poors Index versus the Lipper Growth and Income fund index.

This is important.

The Lipper Growth and Income Fund Index is still an AVERAGE. When you buy a fund, you don't buy an average, you buy a particular fund. Over the last 15 years in growth and income funds, for instance, you could have enjoyed annualized returns of 16 to 17 percent with Vanguard Windsor, Mutual Shares, FPA Paramount, Washington Mutual Investors, Dodge and Cox Stock, Fundamental Investors, or Neuberger & Berman Guardian fund. That's a lot higher than the average 12.88 percent annualized return for the 77 funds with 15 year track records. But if you had the poor luck to pick the bottom performers, you could have suffered actual loses with two Steadman funds.

You lose the extreme gains with an index fund but you also miss the wipe-outs. And that's a major concern to retirees who can't replace the money.

Now look at the up-side. While it is necessary to reduce withdrawal rates to 6 percent to avoid long term losses of principal, the upside potential for gain is incredible if you don't happen to pick one of the worst periods to start investing.

How great is that upside?

Try this: even while withdrawing $6,000 a year, you have historical certainty of retaining your principal over 20 years, a 50/50 shot at doubling your money, and a small chance of seeing your original $100,000 investment balloon to over $900,000.

No bond fund or CD will do that.