Laddering With Individual Bonds – Part Three

This article is part of a series; click here to view Part 1.

1.1 provides reasonable approximations for sustainable spending in retirement
as it relates to a bond interest rate (or a fixed return for an investment
portfolio) and a retirement longevity assumption. For a sixty-five-year-old
with $1 million, the exhibit shows sustainable spending levels given both
returns and longevity. The returns can express either nominal or real returns.
If nominal returns, then the spending numbers would also be nominal and would
not adjust for inflation. If the returns are real, however, then spending numbers
are also real and would grow with inflation.

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the retiree sought to buy a retirement income bond ladder through age
ninety-five using Treasury bonds, the 3 percent yield curve assumptions
suggests that the sustainable spending amount is $49,533. Again, because this
is an assumption about nominal bond yields, this spending amount would not
growth with inflation. As inflation is generally a positive number, real
returns are less than nominal returns. With real returns the initial spending
level would be less but would grow with inflation. With the 1 percent TIPS
yield curve assumption, sustainable spending through age ninety-five is $38,364
plus inflation.

Exhibit 1.1 Sustainable Spending for a Sixty-Five-Year-Old with $1 Million of Assets as Based on Fixed Portfolio Returns and Longevity

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fixed return assumptions could be treated as bond yields, in which retirement
income is based on building a ladder of individual bonds. In this case, the
yield would reflect the average yield from the bond ladder if the yield curve
was not otherwise flat. These returns could also reflect the return assumptions
for a diversified investment portfolio. In this case, these returns would
reflect the net return assumption after working through a series of factors.

thirty-year TIPS ladder is as close as we can get to a real-world safe
withdrawal rate for thirty years of inflation-adjusted spending. The exhibit
shows that at current interest rates, this number is less than 4 percent of the
initial retirement date assets. Spending more from an investment portfolio is
based on a hope that a higher return arrives to sustain a higher spending rate.
This is risky. It is important to note that with this bond ladder, nothing will
be left at the end of the thirtieth year. The calculation is risk free for thirty
years, but the possibility of living beyond thirty years must be considered. A
TIPS ladder does not hedge longevity risk. Longevity risk can only be managed
by assuming a more conservative planning age with a lower probability to
outlive, and then spending less to stretch the asset base out over a longer
retirement horizon.

This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon.


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