Many retirees grit their teeth at what they see as the inconvenience of the “required minimum distribution,” commonly referred to as the RMD. It’s the amount of money expressed as a percentage that people have to take from their combination of retirement accounts when they reach the age of 70 1/2.
With people working longer these days, many are still employed beyond 70 and don’t need the money. They would prefer to just leave it in the plan to compound and give to their children or to a charity someday.
Not everyone has this otherwise delightful problem, so we should examine the considerations that arise for those staring down the barrel of the RMD.
With the right allocation of investments, a person doesn’t have to lose any sleep. They can rest assured that they will not outlive their money if they take the RMD, which starts at 3.65 percent and marches up slowly. It doesn’t reach 10 percent until age 90.
The key lies in gaining some familiarity as to what to expect from different combinations of asset classes — meaning the mix of different investment types we decide on as investors.
Industry literature offers a wide swath of history to go on when we struggle to make an informed investment decision, but some of the most thorough (and readable) research has been compiled by Craig Israelson of Brigham Young University. His books and articles make the case for having a mix of equity and bond investments, with 70 percent in equity and 30 percent in fixed income.
Israelson’s most recent article in AAII Journal tracks, over a 47-year period, an equal mix of large-cap stocks, small-cap, international stocks, real estate, commodities, bonds and cash — all in equal percentages and rebalanced annually.
The nominal return of this mix was 9.75 percent, and the “real” return was 5.5 percent. The difference of 4.25 percent was the amount of total return attributable to inflation. Or, to put it another way, after inflation and subtracting the higher cost of what you had to buy in retirement, your real gain was just the 5.5 percent.
By comparison, an all-stock portfolio represented by the 500 index would have earned 10.31 percent during the period, with about a half-percent more real return.
However, regardless of how fond Warren Buffett and John Bogle may be of the 500 index, the worst-case, three-year cumulative return for the index was a minus-37.61 percent (nominal) — while the seven-investment mix dropped just 13.32 percent during that same major downdraft.
This was all happening back in the 1970s, if that’s any consolation, but it’s important to know that bad things can happen and that the government may not always be of a mind to step in and save the day as it did during the recent major crash.
Something to bear in mind, also, is the fact that the 500 index is concentrated in just 50 of the largest companies that make up about 50 percent of the value of the entire investment class. The remaining 450 companies represent the second half. There’s not much diversification.
The seven-asset class approach carves up the pie more effectively. While the 500 index averaged a zero return per year for the 10 years ending in 2010 — its “lost decade” — a typical mix of different asset classes earned an average of about 6 percent during the same period.
What all these statistics tell us is that we can gain a comfort level from having assets committed to equities as long as they are spread across different investment styles and types with a complement of fixed-income securities (bonds) representing about 30 percent of the total. This has always been the sweet spot for investors wanting to gain as much upside as possible while generating a reasonable amount of protection against short-term calamities.
Looking at these numbers should convince most people that they can safely extract about 5 or 6 percent per year and never run out of money — about twice what the RMD requires anyway until we reach our mid 80s.