dummybook.jpgIs there a "How to cash out for Dummies" manual?

Q. I'm in my 50s with considerable savings. I'm also pretty good at my sales job. I am like many, however, in that I know how to save but have no idea how to pragmatically prepare for retirement income. Is a $1 million investment portfolio going to send me dividends that will pay the bills? Can I generally anticipate a return of 6 percent a year? Is there a "How to Cash Out for Dummies" manual? --B.H., via email

A. You can get the CliffsNotes for the "How to Cash Out for Dummies" manual on any magazine newsstand -- if you hurry. Just pick up copies of the October issues of Kiplinger's, Money and Smart Money. The editors at all three magazines, in a burst of simultaneous ideation, made your question their cover story.

Kiplinger's cover leads with "Make Your Money Last FOREVER!"

On its cover, Money offers a special 43-page report, "Retire Rich: How to Make Your Money Last a Lifetime."

And the cover of Smart Money offers "Stay Rich! How to Make Your Money Last Forever."

The articles cover the basics on your concern, which is called "longevity risk" in polite circles. For the rest of us it's just a big-time version of the old "end of the money before the end of the month" problem.

One way to think about this is to ask yourself what investment return you'll need to have the same purchasing power forever. If inflation averages 3 percent, you'll need to have your portfolio grow by at least that much each year -- after you have taken your income and paid for investment management. If you start at 4 percent income -- which is what most financial planners recommend these days -- you'll need a total portfolio return of 7 percent net of investment expenses.

That may seem like a modest number, but you can't get it without taking some risk. If your entire portfolio was in tax-deferred accounts, you could invest in Treasury Inflation Protected Securities (TIPS) and have about 2.3 percent a year to spend, adjusted for inflation, each year.

But I bet that won't float your boat. If you've earned enough to be able to accumulate a $1 million portfolio, odds are you'd be seriously inconvenienced by having to live on $23,000 a year.

From that point on it's all a matter of choosing how to arrange your assets so that you can maximize your return, with the least risk. Sadly, it isn't easy to get objective advice about this because the financial services industry is structured so that it gets the most income when you take the most risk -- by investing in equities. Worse, I know of no major firm that considers its charges when it tells you how much income you can take. The net result is that most people are likely to have significantly more risk in their portfolios than they should have.

Based on historical data, it should be possible to achieve a 7 percent total return with a simple mixture of large-capitalization stocks (such as the S&P 500) and intermediate bonds. According to Ibbotson Associates, for instance, the long-term return on large common stocks has been 10.4 percent annualized, while the long-term return on intermediate-term government bonds has been 5.3 percent. Over the same period, inflation has run at an annualized rate of 3.0 percent.

A conservative 40 percent equity/60 percent fixed-income portfolio could be expected to produce a long-term annualized return of 7.34 percent -- enough to meet the 7 percent total return goal, excluding management expenses. Build a traditional balanced portfolio that's 60 percent equities, 40 percent fixed-income, and the long-term annualized return would be 8.36 percent.

If these returns were absolutely steady, life would be simple. But the returns vary greatly. A few really bad years can do enormous damage to your portfolio -- and to your long-term standard of living. That's why your withdrawal rate is limited.

The only way to cope with this is through portfolio diversification, hoping that adding different asset classes -- such as international stocks, REITs, and life annuities -- can (1) smooth the annual return and (2) reduce risk.

No matter how the portfolio is constructed, however, our increasing longevity makes it difficult to withdraw more than 5 percent a year from our nest eggs.

On the web:

Kiplinger's -- cover story


Smart Money -- "Stay Rich!"