Q. You often say people approaching retirement should plan on taking no more than 4 percent of their investment fund per year in retirement. Many others say the same. Otherwise, they'll run out of money. But if my investments average about 8 percent a year, why can't I plan on taking about 8 percent a year of my investment total in retirement?  —R. O., by email

A. The reason you can’t take 8 percent from an account that averages an 8 percent return is that the return isn’t a steady 8 percent. The actual return will vary. It will be up a good deal some years, down a lot in others. If the return were a steady flow of dividend or interest income it would be another matter.

Here’s an illustration: Suppose you have a good year. Your $100,000 account doubles to $200,000, a 100 percent return. Unfortunately, the market declines by 50 percent in the following year. This takes your $200,000 account back down to $100,000. Your average return was 25 percent (100 minus 50 divided by 2). But your annualized return was zero.

The problem gets worse if you make withdrawals based on the average return. If you removed $16,000 from your $200,000 account you’d start the second year with $184,000. If it lost half its value in the second year, your investment would be down to $92,000. And that would be before you made the second withdrawal of $7,360. This would take the amount invested at the beginning of the third year down to $84,640. So you’d have a portfolio death spiral.

There is a technical phrase for this: Investment nerds call it “variance sink.” An investment with large ups and downs— variance— has a bigger difference between the average return and the geometric or annual compound return than an investment with small ups and downs.

In a low variance investment— such as intermediate term government bonds— the average return and the geometric return are about the same.  But in stocks, with lots of ups and downs, the average return overstates true geometric return.
All the research on safe withdrawal rates is about the impact of market turbulence on portfolios with regular distributions. Inflation compounds the problem. It causes the dollar amount of your withdrawals to rise over time.

Q. About five years ago my wife and I transferred our IRAs from Fidelity to a major brokerage firm. Our advisor at firm recommended American Funds.  

Six months ago, our advisor said we should sell our American Funds and invest in an advisory product from his brokerage house. Although we made money with the American Funds, did we lose all of the costs of purchasing them?  If we want to get out of the advisory product and go back to American Funds, would we incur more fees to do this?

Our IRAs total about $250,000.  Was it wise to change from American Funds to the advisory product?  Are there better options for us? We are in our 70s.  Are managed accounts the way to go? —C.V., Austin, TX

A. Yes, the initial commission you paid for the American Funds is gone. I think you will find that the total cost of managing your money has at least tripled with the move to the advisory product.

The basic program free is 1.35 percent to 1.50 percent. The costs of the mutual funds used are additional.  This compares to typical expenses of 0.65 percent a year with American Funds. Basically, your advisor has increased his income from the 0.20 percent of your investments he gets as a 12b-1 fee to whatever portion of the advisory product fee he gets from his firm.

The new arrangement works very nicely for your broker. It also works nicely for his firm. But it is highly unlikely that your long-term returns will be better than they were under the lower cost American Funds.

Sadly, you would have to pay a commission again if you wanted to return to American Funds— hopefully not to the same broker. The good news is that a $250,000 commitment may qualify for a substantial commission discount on the purchase of American Funds— 2.5 percent. If so, you will recoup the new commission cost in a bit less than 2 years due to the lower cost of American Funds.