The primary objective of most of our clients is simple: not to outlive their resources. The mechanics of how this might be accomplished usually isn't quite as simple. Much of our work with clients revolves around the two most critical risks that we have to analyze: market risk and shortfall risk. The former applies to the variability of values in the market that is part of investing. The latter risk concerns the possibility of depleting your resources before your death.

The present investment environment provides a good example of how these risks and the trade-offs work. On one hand, we can determine that we aren't willing to accept any market risk and therefore invest all our resources in 10 year U.S. Treasury notes at their current yield of about 1.50% annually. If your withdrawals from the portfolio average 4% per year (a typical retirement scenario), it is obvious that you will eventually deplete the portfolio since withdrawals exceed the return by 2.50% per year before the impact of inflation and taxes. Inflation averaged 3% per year for the past 100 years, and taxes will absorb another portion of the return if the investments are in taxable accounts. This is ugly math!

On the other hand, if you invest in the market and accept the ebb and flows that go with that (remember - volatility is the reason you can obtain premium returns), you might achieve a 6 or 7% return over time. Some years (about one in four on average) will be negative while some years will be produce double digit returns. If we subtract inflation from the returns, we should have somewhere in the neighborhood of the amount that we are withdrawing each year. That is, we are maintaining purchasing power which is critical in 25-35 year retirement timeframes. (The attached chart shows the role stocks play in avoiding shortfall risk.) The math works, but it requires discipline and focus on our long-term objectives.

Investing is about making decisions in the face of uncertainty. Your choices here are that you can settle for a strategy that will very likely lead to an undesirable outcome (running out of money), or you can accept market risk in return for a much improved likelihood of not running out of money. Choose wisely.