| Many retirees have an interest-only approach to | | | | big bite out of that $4,179/month. You would be |
| spending their retirement savings. My own | | | | wiser to spend less in the beginning, so that you |
| grandfather -- who experienced the Great | | | | could increase your retirement withdrawals with |
| Depression as a young adult -- invested his entire | | | | inflation. |
| savings in certificates of deposit (CDs). Even when as | | | | It is easy to calculate the inflation-adjusted |
| he approached his 90th birthday, he was anxious | | | | expenditures your retirement savings could sustain. If |
| about spending more than the interest his CDs could | | | | you expect to consistently earn at least 4%/year in |
| generate. So he lived an extremely frugal retirement | | | | CDs, but you expect inflation to average 3%, you |
| lifestyle. | | | | are expecting -- roughly -- only about a 1% real |
| Unfortunately, the yields on CDs have been terrible | | | | return on your investments per year. Enter |
| for most of this decade. Yields on 3-month CDs | | | | "=PMT(Rate = 0.01/12, Nper = 480, $1,000,000)" into |
| averaged under 3% for four straight years, in | | | | an Excel spreadsheet, and it will return a value of |
| 2002-2005. They briefly rebounded to 5% in 2007, | | | | -$2,529, meaning you could withdraw $2,529/month |
| but they have fallen rapidly in 2008. Living off of CD | | | | the first month, and increase that amount by 3% |
| interest is a hard way to live. | | | | year for 40 years. This approach to retirement |
| There is a better way to calculate how much of your | | | | spending would smooth out the purchasing power of |
| savings you can afford to spend. Treat your | | | | your retirement savings over your retirement. |
| retirement nest egg like a long-term reverse | | | | Unfortunately, $2,529/month on a $1 million portfolio |
| mortgage. Plan on spending the interest -- and some | | | | over a 40-year time span isn't too exciting. But that's |
| of the principal too -- over a period of, say, 40 | | | | what you may be stuck with if you stick to CDs. |
| years, or longer if there is a reasonable chance of | | | | Why loan the banks your money at such a low rate |
| you living past that. In the first few years, most of | | | | of interest? Why let them keep most of the profits |
| your spending will come from the interest you earn. | | | | from your capital? |
| In the last few years, most of your spending will | | | | So drop the CDs. And get some TIPS -- that is, |
| come from the principal. Just like a mortgage. | | | | Treasury Inflation-Protected Securities -- for your |
| To calculate the mortgage-like expenditures your | | | | portfolio. As of Nov. 1, 2008, TIPS boasted a real |
| retirement savings can sustain, you can use an online | | | | yield of more than 3%/year. Try plugging |
| mortgage calculator or Excel's PMT() function. For | | | | "=PMT(Rate = 0.03/12, Nper = 480, $1,000,000)" into |
| example, if you expect to consistently earn at least | | | | an Excel spreadsheet. A portfolio of TIPS |
| 4% interest/year on $1,000,000 invested in CDs over | | | | consistently yielding 3%/year over a 40-year time |
| 40 years (480 months), enter "=PMT(Rate = 0.04/12, | | | | frame would support inflation-adjusted retirement |
| Nper = 480, $1,000,000)" into an Excel spreadsheet. | | | | withdrawals of $3,580/month. This is 40% more than |
| The formula would return -$4,179, meaning your $1 | | | | the inflation-adjusted withdrawals that the same |
| million portfolio would let you spend $4,179/month for | | | | portfolio, if invested in nominal 4% CDs, and |
| 480 months. | | | | assuming a 3% inflation rate, would sustain. |
| Unfortunately, in 40 years, inflation will likely take a | | | | |