1. Retirement Income

2. Then and Now Asset allocation before and after retirement
Before retirement
Accumulation
Long-term growth
Current savings
Time to recover
Tax-deferred growth
After retirement
Disbursement
Long-term growth
Current income
Downturns immediately felt
Minimum required distributions
Taxes
Then and Now
Portfolios for those saving for retirement and those in retirement are different as goals, needs, and risk profiles change.
Retirement presents new challenges for investors as their goals move from accumulation to distribution of their wealth. Before retirement, the dollar value of future goals can be hard to quantify because it may be many years before the goals are realized. In retirement, the goals are very real as retirees change from saving for them to paying for them.
Pulling money out of a portfolio that is also intended to provide long-term growth can be a balancing act. Retirees find themselves having to manage the opposing forces of long-term growth and current income. They are concerned with preserving the wealth they have accumulated, while still providing the growth they need to sustain periodic withdrawals throughout their retirement.
In addition, downturns can have more severe effects on the life of a retirement portfolio. Before retirement, market dips could be endured and even used as an opportunity to accumulate more investment shares at lower prices. During retirement, however, the effects of market dips are compounded by the periodic withdrawals retirees make from the portfolio, leaving even less principal to work for long-term growth.
Before retirement, investments had the ability to grow tax-deferred. After retirement, retirees usually have to pay income taxes as money is distributed from the portfolio. Furthermore, retirees also have to start making minimum required distributions (MRD) from many of their tax-deferred accounts as they approach 70½ years of age.
© 2009 Morningstar, Inc. All rights reserved. 3/1/2009

3. Retirees Face Numerous Risks
Longevity
Long retirement horizons—
a couple aged 65 has 25%
chance of a survivor living
to age 96
Withdrawals
What rate is sustainable?
Sequencing by tax bracket
Managing RMDs
Retiree spending
Replacement ratio
Essential versus lifestyle
expenses
Medical expenses
Solvency
Pension plans and retiree
benefits—a thing of the past
Social Security and Medicare
Retirement income
Retirees Face Numerous Risks
There are a number of risks that cause uncertainties for retirees.
Longevity risk: The risk of retirees outliving their portfolio is especially a concern for those taking advantage of early retirement or those who have a family history of longevity. Retirees need to consider how long they may possibly live. For a couple aged 65, there is a 25% chance that one of them will live to age 96—a 31 year retirement time horizon!
Solvency risk: The problems with government and employer sources should be a concern for retirees. Social Security and Medicare are in a situation in which they will likely be forced to reduce benefits over time, while pension plans frequently default or reduce benefits to those already in retirement.
Savings risk: Most people simply aren’t saving enough for retirement. In 2005, the personal savings rate was 0.4%—the first year savings as a percentage of disposable income fell below 1% since the Great Depression. It grew slightly to 0.7% in 2006, 0.6% in 2007 and 1.7% in 2008 (Bureau of Economic Analysis).
Inflation risk: Inflation erodes the value of savings and reduces returns. In order to combat the sometimes extreme fluctuations of the stock market, retirement portfolios are often weighted more toward fixed-income investments. Conservative investments that pay a fixed income run the risk of being unable to keep pace with inflation. Furthermore, health care inflation rates have recently been 5% annually.
Market volatility risk: Market volatility may cause portfolio values to fluctuate both up and down. If market drops or corrections occur early during retirement, the portfolio may not be able to cushion the added stress of systematic withdrawals. This may lead to the portfolio being unable to provide the necessary income for the lifestyle desired, or the portfolio may simply run out of money too soon. Retirees must consider how investments should be allocated in retirement.
Retiree spending risk: What level of pre-retirement income will people need in retirement? Some may be able to live on less, but others may need more. An assessment of essential versus lifestyle expenses in retirement is needed.
Withdrawal risk: Retirees will need guidance on what withdrawal rate may be sustainable over a long retirement, as well as the sequence of withdrawals and managing Required Minimum Distributions (RMDs). Retirees will have to pay income taxes as money is distributed from their portfolios. As retirees approach 70½ years old, they have to start making required minimum distributions (RMDs) from their tax-deferred accounts. Depending on the size of the portfolio, this could mean retirees are pulling out more than they need in order to satisfy the RMD and paying unnecessary taxes on the larger amount.
Market volatility
Uncertain returns and
income
Impact of point in time
Asset allocation and location
Savings
Under-funded defined
contribution accounts
Most Americans have an
enormous savings gap
Inflation
Erodes the value of savings
and reduces returns
Health care inflation 5%
© 2009 Morningstar, Inc. All rights reserved. 3/1/2009

4. Retirees Should Plan for a Long Retirement Probability of a 65-year-old living to various ages
100%
• Male
• Female
• At least one spouse 78 81 86
75% 85 88 91
50%
Retirees Should Plan for a Long Retirement
Longevity risk is the possibility that a person will outlive his or her retirement savings. Chances are, people are going to live longer than they think.
While living longer is a good thing, it can pose some challenging financial issues in retirement. Longevity risk is perhaps one of the biggest risks that investors will face as they enter retirement.
Accounting for longevity risk in retirement planning is more important than ever because people today are living significantly longer than prior generations, due to advances in medicine, diet, and technology. This risk is compounded by medical and health-care expenses that are rising considerably faster than the rate of inflation.
Most people underestimate how long they are likely to live. Too often, people base their financial planning upon their life expectancy, which is the average age at which someone is expected to die. In the United States, the median life expectancy of a 65-year-old man and woman is 85 and 88, respectively. What people do not always realize is that this is the median. Half of the population will live longer, often much longer than their life expectancy.
The image above illustrates the probabilities of a 65-year-old living to various ages. For example, there is 25% chance that a 65-year-old man will live to age 91, a 65-year-old woman to age 93, or at least one spouse of a 65-year-old couple to age 96. Retirees should plan for a long retirement, perhaps as long as 30 years. If retirees’ financial plans assume they live only to the median life expectancy, they run a greater risk of depleting their retirement savings.
There are a couple additional reasons to use conservative mortality assumptions. First, the fact that your clients are working with a financial advisor means that their expected mortality is likely to be older than the population at large due to better health-care, nutrition, etc. Second, consider the downside risk—you would rather be conservative and have money left over than have your clients run out of money before they die.
Source: Annuity 2000 Mortality Tables—Transactions, Society of Actuaries, 1995–1996 Reports. 91 93 96
25% 0%
65 years
70 years
75 years
80 years
85 years
90 years
95 years
100 years
105 years

5. Retirees Should Plan for a Long Retirement Probability of a 65-year-old living to various ages
100%
• Male
• Female
• At least one spouse 78 81 86 75 85 88 91 50
Retirees Should Plan for a Long Retirement
Longevity risk is the possibility that a person will outlive his or her retirement savings. Chances are, people are going to live longer than they think.
While living longer is a good thing, it can pose some challenging financial issues in retirement. Longevity risk is perhaps one of the biggest risks that investors will face as they enter retirement.
Accounting for longevity risk in retirement planning is more important than ever because people today are living significantly longer than prior generations, due to advances in medicine, diet, and technology. This risk is compounded by medical and health-care expenses that are rising considerably faster than the rate of inflation.
Most people underestimate how long they are likely to live. Too often, people base their financial planning upon their life expectancy, which is the average age at which someone is expected to die. In the United States, the median life expectancy of a 65-year-old man and woman is 85 and 88, respectively. What people do not always realize is that this is the median. Half of the population will live longer, often much longer than their life expectancy.
The image above illustrates the probabilities of a 65-year-old living to various ages. For example, there is 25% chance that a 65-year-old man will live to age 91, a 65-year-old woman to age 93, or at least one spouse of a 65-year-old couple to age 96. Retirees should plan for a long retirement, perhaps as long as 30 years. If retirees’ financial plans assume they live only to the median life expectancy, they run a greater risk of depleting their retirement savings.
There are a couple additional reasons to use conservative mortality assumptions. First, the fact that your clients are working with a financial advisor means that their expected mortality is likely to be older than the population at large due to better health-care, nutrition, etc. Second, consider the downside risk—you would rather be conservative and have money left over than have your clients run out of money before they die.
Source: Annuity 2000 Mortality Tables—Transactions, Society of Actuaries, 1995–1996 Reports. 91 93 96 25
65 years old 70 75 80 85 90 95
100
105
Source: Annuity 2000 Mortality Tables. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

6. Personal Savings Expected to Play a Larger Role in Retirement Survey of retirement income sources
100%
• Workers (Expected)
• Retirees (Reported)
94% 80
80%
74%
73%
69% 60
59%
53%
48% 40
Personal Savings Expected to Play a Larger Role in Retirement
The sources from which current workers expect to receive their income during retirement differ from the sources from which current retirees actually receive their income.
The graphs illustrate that while only 48% of current retirees utilize their personal savings for retirement income, 73% of current workers anticipate personal savings to play a role during retirement. 74% of workers expect to receive retirement income from an employer-sponsored retirement savings plan, while only 36% of those already retired actually receive income from such a source. A whopping 94% of retirees say they derive some of their income from Social Security as opposed to 80% of current workers who expect to rely on this source.
Traditionally, Social Security and company pension plans were primarily depended on to fund an individual’s retirement. As the retirement income gap grows larger, however, the current belief is that these established retirement income sources will no longer play as prominent a role. Personal savings are expected to play a much larger role funding future retirements.
Source: Employee Benefit Research Institute, 2008 Retirement Confidence Survey.
36%
34% 20
Social Security
Employer-sponsored
retirement savings
plan (ex. 401k)
Other personal
savings/investments
Individual Retirement Account (IRA)
Employer-provided
traditional pension plan
Source: Employee Benefit Research Institute, 2008 Retirement Confidence Survey. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

7. Social Security is Under Strain From Fewer Workers Per Retiree Ratio of workers to beneficiary
6.0
5.0
4.0
3.0
Social Security is Under Strain From Fewer Workers Per Retiree
Concern over the Social Security program’s ability to fund itself over the long term is mounting. With baby boomers nearing retirement age, a strain on Social Security’s ability to meet its obligations is likely to develop.
Since the Social Security program is a “pay-as-you-go” system, it is supported by taxes from current workers to pay the benefits of current retirees. According to the Social Security Administration, the number of workers paying into the system for every person has plummeted from 42 workers per beneficiary in 1945 to 3.3 in 2008, and is projected to fall to 2.1 by Since the ratio of workers to retirees is expected to continue declining, a shortfall in future Social Security funding is likely.
The trustees of the Social Security program predict that in 2017, Social Security benefit payments will begin to exceed Social Security tax income. Furthermore, they are forecasting that the Social Security trust fund will be exhausted in 2041 unless changes are made.
In the face of such demographic pressure, the Social Security system will eventually collapse unless Congress acts to increase payroll taxes, reduce benefits, or push back the eligibility date for benefits. Most experts believe that all three actions are likely, and the longer Congress delays action, the greater the pain will be for investors.
Source: The 2008 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, March 2008, Social Security Administration.
2.0
1.0
Historical
Estimated
0.0
1960
1970
1980
1990
2000
2010
2020
2030
2040
2050
© 2009 Morningstar, Inc. All rights reserved. 3/1/2009

8. Social Security is Under Strain From Fewer Workers Per Retiree Ratio of workers to beneficiary
6.0
5.0
4.0
3.0
Social Security is Under Strain From Fewer Workers Per Retiree
Concern over the Social Security program’s ability to fund itself over the long term is mounting. With baby boomers nearing retirement age, a strain on Social Security’s ability to meet its obligations is likely to develop.
Since the Social Security program is a “pay-as-you-go” system, it is supported by taxes from current workers to pay the benefits of current retirees. According to the Social Security Administration, the number of workers paying into the system for every person has plummeted from 42 workers per beneficiary in 1945 to 3.3 in 2008, and is projected to fall to 2.1 by Since the ratio of workers to retirees is expected to continue declining, a shortfall in future Social Security funding is likely.
The trustees of the Social Security program predict that in 2017, Social Security benefit payments will begin to exceed Social Security tax income. Furthermore, they are forecasting that the Social Security trust fund will be exhausted in 2041 unless changes are made.
In the face of such demographic pressure, the Social Security system will eventually collapse unless Congress acts to increase payroll taxes, reduce benefits, or push back the eligibility date for benefits. Most experts believe that all three actions are likely, and the longer Congress delays action, the greater the pain will be for investors.
Source: The 2008 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, March 2008, Social Security Administration.
2.0
1.0
Historical
Estimated
0.0
1960
1970
1980
1990
2000
2010
2020
2030
2040
2050

9. Inflation Significantly Erodes Purchasing Power Over Time Effects of 3% inflation on purchasing power
$100k
$85,873 80
$73,742
$63,325 60
$54,379
$46,697
$40,101 40
Inflation Significantly Erodes Purchasing Power Over Time
Inflation is commonly defined as the rise in prices for goods and services over time. The average inflation rate from 1926–2008 was 3%. Investors often do not understand the damage inflation can do over long periods of time to their spending power. This may be because the annual average of 3% seems relatively low. Over long time horizons, such as a 30-year retirement, an annual increase in prices of 3% can have a tremendous impact on investors’ financial situation.
Inflation erodes the value of investors’ savings. The graph demonstrates that $100,000 of income today will only be worth $85,873 of value in as little as five years, or roughly 14% less than today. Over the course of a typical 30-year retirement, the income will be reduced by nearly 60% to $40,101.
To make matters worse, medical expenses, which can be a considerable factor for retirees, are rising faster than the average inflation rate. A recent estimate from the Centers for Medicare & Medicaid Services suggests medical inflation may be as high as 6.9% annually over the period 2006–2016. Investors planning for retirement would be wise to plan for an inflation rate higher than 3%.
About the data
Inflation is represented by the Consumer Price Index and the medical inflation estimate is measured by the National Health Expenditures per capita from the Centers for Medicare & Medicaid Services, Office of the Actuary, U.S. Department of Health and Human Services. 20
0 Years 5 10 15 20 25 30
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

10. Hot-Hand Fallacy: Chasing Fund Performance Wealth versus cash flows 1999–2008
$30k
• Growth of $10,000
10-year fund total return = –0.50%
10-year average investor return = –12.55%
• Cash flows
$1,400m
$25k
$1,200m
$1,000m
$20k
$800m
$600m
$15k
$400m
Hot-Hand Fallacy: Chasing Fund Performance
Investor return, also known as asset-weighted return, factors in the timing of investors’ purchases and sales. It takes into account the fact that not all of a fund’s investors bought it at the beginning of a period and held it until the end. Therefore, investor return depicts the return earned by a fund’s typical investor. Investor returns support the theories about investors’ poor timing.
The image illustrates the divergence in the total return and investor return for a fund selected from Morningstar’s open-end mutual fund database. The fund’s 10-year return was –0.50%, but its 10-year investor return was –12.55%—quite a difference. The fund’s net cash flow tells the story of the discrepancy. Investors piled into the fund during its run-up and then fled as the fund’s returns plummeted. Investors were still leaving the fund as it rebounded and consequently were not around to recoup some of their losses.
Some fund companies develop numerous trendy funds that tend to attract investors chasing whatever is hot, and otherwise do little to encourage a long-term investment perspective. These types of funds tend to produce relatively poor investor returns. On the other hand, most funds with consistently superior investor returns are from shops that encourage long-term investing and discourage short-term trading.
Morningstar investor returns measure how the typical investor in that fund fared over time, incorporating the impact of cash inflows and outflows from purchases and sales. It is not one specific investor’s experience, but rather a measure of the return earned collectively by all the investors in the fund. Total return measures the percentage change in price for a fund, assuming the investor buys and holds the fund over the time period, reinvests distributions, and does not make any additional purchases or sales. Investor returns are not a substitute for total returns but can be used in combination with them.
Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges, expenses and other information. Investors should read the prospectus carefully and consider this information before investing or sending money.
About the data
The fund illustrated in this example was selected from Morningstar’s open-end database.
$10k
$200m $0
$5k
–$200m
–$400m $0
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. All rights reserved. 10/1/2008

11. Hot-Hand Fallacy: Chasing Fund Performance Wealth versus cash flows 1999–2008
$30k
• Growth of $10,000
10-year fund total return = –0.50%
10-year average investor return = –12.55%
• Cash flows
1,400 25
1,200
1,000 20
800
600 15
400
Hot-Hand Fallacy: Chasing Fund Performance
Investor return, also known as asset-weighted return, factors in the timing of investors’ purchases and sales. It takes into account the fact that not all of a fund’s investors bought it at the beginning of a period and held it until the end. Therefore, investor return depicts the return earned by a fund’s typical investor. Investor returns support the theories about investors’ poor timing.
The image illustrates the divergence in the total return and investor return for a fund selected from Morningstar’s open-end mutual fund database. The fund’s 10-year return was –0.50%, but its 10-year investor return was –12.55%—quite a difference. The fund’s net cash flow tells the story of the discrepancy. Investors piled into the fund during its run-up and then fled as the fund’s returns plummeted. Investors were still leaving the fund as it rebounded and consequently were not around to recoup some of their losses.
Some fund companies develop numerous trendy funds that tend to attract investors chasing whatever is hot, and otherwise do little to encourage a long-term investment perspective. These types of funds tend to produce relatively poor investor returns. On the other hand, most funds with consistently superior investor returns are from shops that encourage long-term investing and discourage short-term trading.
Morningstar investor returns measure how the typical investor in that fund fared over time, incorporating the impact of cash inflows and outflows from purchases and sales. It is not one specific investor’s experience, but rather a measure of the return earned collectively by all the investors in the fund. Total return measures the percentage change in price for a fund, assuming the investor buys and holds the fund over the time period, reinvests distributions, and does not make any additional purchases or sales. Investor returns are not a substitute for total returns but can be used in combination with them.
Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges, expenses and other information. Investors should read the prospectus carefully and consider this information before investing or sending money.
About the data
The fund illustrated in this example was selected from Morningstar’s open-end database. 10
200 5
–200
–400
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. All rights reserved. 10/1/2008

12. Inflation and Taxes Reduce Returns Compound annual returns,1926–2008
Stocks
Bonds
Cash
10%
9.6% 8
6.4% 6
5.7%
4.4% 4
3.7%
Inflation and Taxes Reduce Returns
The adverse effects of inflation and taxes on investment returns become especially pronounced over the long run. Comparing the returns of different asset classes both before and after inflation and taxes is helpful in understanding why it is so important to consider inflation and taxes when making long-term investment decisions.
This image illustrates the compound annual returns of three asset classes before and after considering the effects of inflation and taxes. Over the past 83 years, inflation and taxes have dramatically reduced the returns of stocks, bonds, and cash.
Of the asset classes considered, stocks are the only asset class that provided significant growth. Government bonds fell well short of inflation. Treasury bills, however, fared the worst. After considering both inflation and taxes, returns were negative.
If you wish to overcome the effects of inflation and taxes, you may want to consider a larger allocation to stocks. Another alternative, if you are able, is to consider tax-deferred investment vehicles.
Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes.
About the data
Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $100,000 in 2005 dollars every year. This annual income is adjusted using the Consumer Price Index in order to obtain the corresponding income level for each year. Income is taxed at the appropriate federal income tax rate as it occurs. When realized, capital gains are calculated assuming the appropriate capital gains rates. The holding period for capital gains tax calculation is assumed to be five years for stocks, while government bonds are held until replaced in the index. No state income taxes are included.
Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Government bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for transaction costs.
2.6% 2
0.5%
0.7%
–0.7% –2
Return
After
After taxes
Return
After
After taxes
Return
After
After taxes
inflation
& inflation
inflation
& inflation
inflation
& inflation
Past performance is no guarantee of future results. Assumes reinvestment of income and no transaction costs. Inflation rate over the time period 1926–2008 was 3.0%. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

13. Sustainable Withdrawal Rates Vary Over Time Rolling 30-year periods 1926–2008
12%
• 75% stocks/25% bonds
• 50% stocks/50% bonds
• 25% stocks/75% bonds 10 8 6
Sustainable Withdrawal Rates Vary Over Time
When approaching retirement, the first question many investors ask is how much money they can safely take from their portfolio each year. A simplistic way of looking at this is a withdrawal rate, expressed as a percentage of your investment assets.
Since people are spending more years in retirement, it may be helpful to look at what previous retirees could have withdrawn over a long retirement.
This image shows the historical maximum sustainable inflation-adjusted withdrawal rate over rolling 30-year periods for three hypothetical stock and bond portfolios from 1926–2008. Rolling period returns are a series of overlapping, contiguous periods of returns. In this example, the first point represents the rolling period of January 1926–December 1955, the second is February 1926–January 1956, the third is March 1926–February 1956, and so on.
As shown, the amount that could have been withdrawn over each 30-year period varied greatly. For example, the 75% stock/25% bond portfolio was able to provide a higher maximum sustainable withdrawal rate for those who retired in the late 1930s to the mid–1950s. The same portfolio, however, provided a much lower maximum sustainable withdrawal rate to those who retired in the late 1960s and early 1970s. This is due to the negative stock market returns that occurred in the early years of retirement.
Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than bonds.
About the data
Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, and fees from Morningstar. All withdrawal rates are represented by an inflation-adjusted percentage of the starting portfolio balance that, if withdrawn in each of the 30 years of the hypothetical retirement horizon, would have resulted in an ending portfolio balance of $0. Annual fees of 0.97% for stocks and 0.79% for bonds were assumed. An investment cannot be made directly in an index. 4 2
Jan 1926
Dec 1955
1931
1960
1936
1965
1941
1970
1946
1975
1951
1980
1956
1985
1961
1990
1966
1995
1971
2000
1976
2005
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

14. Withdrawal Rate You Can Sustain May Be Lower Than You Think Average: 1926–20086%
5.95%
5.11% 5
4.25% 4 3
Withdrawal Rate You Can Sustain May Be Lower Than You Think
While it is helpful to know that withdrawal rates can vary greatly over time depending on asset allocations and market performance, investors will still need guidance regarding what rate may be reasonable and sustainable.
Historically, as shown in the image, withdrawal rates that could support an investor over a typical 30-year retirement have varied from 4.25% to 5.95%, depending on the asset allocation of the portfolio. Of course, if you lived longer than 30 years, these withdrawal rates would need to be lower.
Unfortunately, there is no magical formula or simple solution. The optimal withdrawal rate will vary from investor to investor, and may vary over time. Many financial planners consider a withdrawal rate of 4%–5% as being reasonable and sustainable over a long retirement horizon. This withdrawal rate can have a profound impact on how much money you need to accumulate before retiring and even on when you can retire.
Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than bonds.
About the data
Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, and fees from Morningstar. Annual fees of 0.97% for stocks and 0.79% for bonds were assumed. An investment cannot be made directly in an index. 2 1
75% Stocks/25% Bonds
50% Stocks/50% Bonds
25% Stocks/75% Bonds
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

15. The Sequence of Returns Can Significantly Affect Your Retirement Sequence of returns matters
Actual historical return sequence
Reversed historical return sequence
$500k
$2.5 mil
400
2.0
300
1.5
200
The Sequence of Returns Can Significantly Affect Your Retirement
The point in time that a person chooses to retire can also affect the ability of his or her portfolio to last throughout retirement.
The images above demonstrate this by showing how the sequence of market returns affects how much a portfolio can grow while sustaining needed withdrawals in retirement. Both images look at a hypothetical 50% stock/50% bond portfolio with an initial value of $500,000 and assume a withdrawal rate of 5% annually, adjusted for inflation.
The image on the left assumes a person retired on January 1, 1973 (right before a bear market) and began making monthly withdrawals in January The result was that the portfolio ran out of money by July 1994.
The image on the right illustrates a hypothetical case where the historical returns occurred in reverse chronological order: The returns from 1994 occurred before the returns from 1993, etc., with the returns from 1973 occurring last. By reversing the sequence of returns, the portfolio experienced high returns in the early years and low returns in the latter years. As a result, the portfolio increased substantially over time, more than tripling in value, despite the ongoing 5% withdrawals.
This hypothetical example highlights that in the early years of retirement, a portfolio being eroded simultaneously by a bear market and withdrawals may not be able to rebuild wealth, even if good returns are experienced in later years. This is relevant because people who retired right before or during the bear market of the early 2000s experienced large declines in portfolio values early in retirement.
Unfortunately, no one can predict what the market might do in the critical years of their retirement. This is why it is particularly important in the early years to manage this risk through effective asset allocation, reducing withdrawal rates and spending, or deferring retirement.
Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes.
About the data
Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond and inflation by the Consumer Price Index. Each monthly withdrawal is adjusted for inflation and each portfolio is rebalanced monthly. An investment cannot be made directly in an index.
1.0
100
0.5
1973
1977
1981
1985
1989
1993
Jul 94
1993
1989
1985
1981
1977
1973
Past performance is no guarantee of future results. Hypothetical value of $500,000 invested at the beginning of 1973 and July Assumes inflation-adjusted withdrawal rate of 5%. Portfolio: 50% large-company stocks/50% intermediate-term bonds. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

16. Discussion of Simulation Criteria and Methodology
Many of the following images were created using Monte Carlo parametric simulation. This model estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used herein are the historical 1926–2008 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.6%, return 11.7%; Bonds: risk 5.7%, return 5.6%; Correlation 0.00; Inflation: return 3.1%.
Note that other investments not considered may have characteristics similar or superior to those being analyzed. Each simulation produces 35 randomly selected return estimates consistent with the characteristics of the portfolio to estimate the return distribution over a 35-year period. Each simulation is run 5,000 times, to give 5,000 possible 35-year scenarios. A limitation of the simulation model is that it assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.
© 2009 Morningstar, Inc. All rights reserved. 3/1/2009

17. Interpreting Confidence Levels in Simulation
Chance of exceeding
Chance of falling short
50%
50%
50%
75%
75%
25%
Interpreting Confidence Levels in Simulation
Confidence levels are a statistical measure that indicate a probability value and are expressed as a percentage. Interpreting confidence levels can often be difficult. The table provided is intended to help interpret confidence levels that are commonly displayed in illustrations of simulated market performance.
In the context of simulating wealth and income in retirement, a 50% confidence level means there is a 50% chance of exceeding the illustrated result and a 50% chance of falling short. This is also considered the median result.
A 75% confidence level means there is a 75% chance of exceeding the illustrated result and a 25% chance of falling short. This confidence level takes more downside scenarios into account than the 50% level does.
A 90% confidence level means there is a 90% chance of exceeding the illustrated result and a 10% chance of falling short. Results shown under these conditions include a significant exposure to expected downside risk.
Unexpected events that are out of an individual’s control are a significant concern for today’s retirees. Prudent retirement planning often means preparing for the worst. For this reason, it is much safer to plan for poor market conditions associated with the 75% or 90% confidence levels.
90% (More conservative)
90%
10%
This table is intended to help interpret 50%, 75%, and 90% confidence levels illustrated in the following images. © 2009 Morningstar, Inc. All rights reserved. 3/1/2009

18. Simulation Can Illustrate the Probability of Achieving Outcomes A visual interpretation of confidence levels in simulation
$10 mil
1 mil
Simulation Can Illustrate the Probability of Achieving Outcomes
Simulation is a tool that can be used to show the probability of achieving certain investment outcomes by performing multiple return scenarios. Simulation estimates this range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a group of asset classes or portfolios.
Typically when simulation is used, thousands of simulations are run to produce thousands of possible outcomes. For simplicity’s sake, the image above presents a snapshot from a simulation that was run just 100 times and produced 100 possible 35-year scenarios for the performance of a sample portfolio. Each line represents one possible 35-year scenario. The values calculated and presented are potential outcomes for an investor's wealth level over a 35-year period, and help determine whether or not the investor will be able to successfully fund his or her retirement goal. The values for each year are subsequently sorted from smallest to largest and can be presented according to various probabilities.
References are often made that there is a certain chance of a particular result. To understand what this means, the image highlights the results for the 50%, 75%, and 90% confidence levels. For example, the line highlighting the 90% confidence level indicates that in 10% of the possible 35-year scenarios (in this case 10 because 100 scenarios were run) show an investor might experience a portfolio shortfall before the number of years shown, while in 90% of scenarios the portfolio might last longer. This could be an illustration of what could happen if the market experienced poor returns. The 50% level means that there is a 50% chance an investor would have a worse result and a 50% chance they’d have a better result.
Determining the appropriate confidence level to use can be a challenge. Everyone tolerates risk in different ways. For some 50/50 is good enough while others desire more conservative estimates that take into account a tougher view of market conditions and provide more of a worst-case scenario. Regardless, using simulation can help investors understand their chances of meeting income needs or experiencing income shortfalls in retirement.
Keep in mind that an investment cannot be made directly in an index.
100k
• 50% confidence level
• 75% confidence level
• 90% confidence level
10k
65 Years old 70 75 80 85 90 95
100
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. 3/1/2009

19. High Withdrawal Rates Will Quickly Deplete Your Assets Simulated portfolio values (90% confidence level)
$1 mil
500k
100
High Withdrawal Rates Will Quickly Deplete Your Assets
Several issues should be examined when determining an investor’s withdrawal rate. Asset allocation, time horizon, and consumption patterns are all important factors in shaping how long portfolio wealth will last.
This image looks at a hypothetical 50% stock/50% bond portfolio and the effect various inflation-adjusted withdrawal rates have on the end value of the portfolio over a long payout period. Each hypothetical portfolio has an initial starting value of $500,000. It is assumed that a person retires at age 65 and withdraws an inflation-adjusted percentage of the initial portfolio wealth ($500,000) each year beginning at age 66. Annual investment expenses were assumed to be 0.97% for stock mutual funds and 0.79% for bond mutual funds.
As illustrated, the higher the withdrawal rate, the greater the chance of potential shortfall. The lower the rate, the less likely an investor is to outlive their portfolio. Therefore, retirees who anticipate long payout periods may want to consider assuming lower withdrawal rates.
The image was created using Monte Carlo parametric simulation that estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used are historical 1926–2008 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.6%, return 11.7%; Bonds: risk 5.7%, return 5.6%; Correlation 0.0; Inflation: return 3.1%. Other investments not considered may have characteristics similar or superior to those being analyzed. The simulation is run 5,000 times, to give 5,000 possible 35-year scenarios. While simulation can produce results that show probabilities of an outcome, the analysis included herein is presented as the 90% confidence level. A 90% confidence level indicates that there is a 90% chance of the outcome being as shown or better. Higher confidence levels are chosen in order to view tougher market conditions. A limitation of the simulation model is that it assumes a constant inflation-adjusted rate of withdrawal, which may not be representative of actual retirement income needs. This type of simulation also assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.
Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed.
About the data
Stocks are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, inflation by the Consumer Price Index and mutual fund expenses from Morningstar. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes or transaction costs. 50
Withdrawal rate: 8% 7% 6% 5% 4% 10
65 years old 70 75 80 85 90 95
100
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. 3/1/2009

20. Market Performance Affects Chance of Portfolio Shortfall Six percent inflation-adjusted withdrawal at three confidence levels
$1 mil
500k
• 50% confidence level
• 75% confidence level
• 90% confidence level
100
Market Performance Affects Chance of Portfolio Shortfall
A low withdrawal rate does not ensure that a portfolio will last throughout retirement and provide the required income need.
Each withdrawal rate has its own set of probabilities for how it will affect a portfolio’s value and ability to provide income in retirement. This is due to market performance. If the market performs well, the portfolio will likely last longer in retirement. Likewise, if the market performs poorly, the chance of shortfall increases.
This image looks at a hypothetical 50% stock/50% bond portfolio and an initial starting value of $500,000. It is assumed that a person retires at age 65 and withdraws $30,000 (inflation-adjusted) per year each year beginning at age 66. This equates to a 6% withdrawal rate. Annual investment expenses were assumed to be 0.97% for stock mutual funds and 0.79% for bond mutual funds. The portfolio has a 90% chance of lasting beyond age 82. There is a 75% chance of lasting beyond age 85 and a 50% chance of the portfolio lasting past age 90.
Investors with a long expected retirement or life expectancy really need to consider how time, withdrawal amounts, and market returns can affect the lifetime of their portfolios. Is now the right time to retire? Are there enough accumulated funds to last throughout retirement while providing the lifestyle desired?
The image was created using Monte Carlo parametric simulation that estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used are historical 1926–2008 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.6%, return 11.7%; Bonds: risk 5.7%, return 5.6%; Correlation 0.0; Inflation: return 3.1%. Note that other investments not considered may have characteristics similar or superior to those being analyzed. The simulation is run 5,000 times, to give 5,000 possible 35-year scenarios. A limitation of the simulation model is that it assumes a constant inflation-adjusted rate of withdrawal, which may not be representative of actual retirement income needs. This type of simulation also assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.
Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed.
About the data
Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, inflation by the Consumer Price Index and mutual fund expenses from Morningstar. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes or transaction costs. 50 10
65 years old 70 75 80 85 90 95
100
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. 3/1/2009

21. Withdrawal Rates and Retirement Horizon Affect Ability to Meet Goals Probability of meeting income needs throughout retirement
Withdrawal rate:
100%
Prob. 4% 80 60 5% 40
Withdrawal Rates and Retirement Horizon Affect Ability to Meet Goals Time horizon and withdrawal rates affect the probabilities of having enough money in retirement.
This image estimates the probabilities of a hypothetical 50% stock/50% bond portfolio meeting income needs at various time intervals into retirement assuming various inflation-adjusted withdrawal rates. Each annual withdrawal is adjusted for the historical 1926–2008 inflation rate of 3.1%. Annual investment expenses were assumed to be 0.97% for stock mutual funds and 0.79% for bond mutual funds.
For example, a person who withdrew 8% per year for income had a 64% chance of meeting income needs 15 years into retirement. The probability of meeting income needs dropped to 26% after just 20 years and 11% after 25 years. As displayed, there can be a substantial risk of outliving one’s assets. Possible solutions include altering portfolio allocations or lowering the amount of income withdrawn each year.
The image was created using Monte Carlo parametric simulation. This model estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used herein are the historical 1926–2008 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.6%, return 11.7%; Bonds: risk 5.7%, return 5.6%; Correlation 0.0; Inflation: return 3.1%. Note that other investments not considered may have characteristics similar or superior to those being analyzed. Each simulation produces 35 randomly selected return estimates consistent with the characteristics of the portfolio to estimate the return distribution over 15-, 20-, 25-, 30-, and 35-year periods. Each simulation is run 5,000 times, to give 5,000 possible scenarios for each time horizon. A limitation of the simulation model is that it assumes a constant inflation-adjusted rate of withdrawal, which may not be representative of actual retirement income needs. This type of simulation also assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.
Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed.
About the data
Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, inflation by the Consumer Price Index and mutual fund expenses from Morningstar. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes. 6% 20 7% 8%
15 years into retirement 20 25 30 35
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. 3/1/2009

22. Probability of Meeting Income Needs Various withdrawal rates and portfolio allocations over a 25-year retirement
86%
35% 4% 0%
97%
71%
28% 5%
95%
79%
52%
27%
11%
92%
60%
42%
26%
88%
76%
62%
48%
36%
4% Withdrawal rate 5% 6% 7% 8%
Probability of Meeting Income Needs
There are a number of factors that can impact whether a portfolio will last through retirement.
The table shows how the amount of withdrawal and various portfolio allocations can affect the chance of meeting income needs over a 25-year retirement. It is assumed that a person retires at year zero and withdraws an inflation-adjusted percentage of the initial portfolio wealth each year beginning in year 1. Annual investment expenses were assumed to be 0.97% for stock mutual funds and 0.79% for bond mutual funds.
A high probability indicates that an investor is more likely to meet income needs in retirement, while a low probability indicates that an investor is less likely to do so and may face shortfall. The chance of a portfolio running out over a long retirement is less likely as the amount withdrawn decreases and as equities are added. Keep in mind that returns and principal invested in stocks are not guaranteed and they have been more volatile (risky) than bonds.
The image was created using Monte Carlo parametric simulation that estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used are historical 1926–2008 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.6%, return 11.7%; Bonds: risk 5.7%, return 5.6%; Correlation 0.00; Inflation: return 3.1%. Other investments not considered may have characteristics similar or superior to those being analyzed. The simulation is run 5,000 times, to give 5,000 possible 25-year scenarios. A limitation of this simulation model is that it assumes a constant inflation-adjusted rate of withdrawal, which may not be representative of actual retirement income needs. This type of simulation also assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.
Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed.
About the data
Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, inflation by the Consumer Price Index and mutual fund expenses from Morningstar. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes.
100%
Bonds
75% B
25% S
50% B
50% S
25% B
75% S
Stocks
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2009 Morningstar, Inc. 3/1/2009

23. Providing for Retirement Income
Retirement risks can be managed by intelligent combination of funds, stocks and bonds, and insurance products
How do you find the right asset mix for retirement?
age and risk tolerance
desire for consumption and bequest
expenses and fees of product choices
Providing for Retirement Income
The risk of being unable to fund goals throughout retirement can be managed by an intelligent combination of funds, stocks and bonds, and insurance products.
Finding the right mix of products and investments for retirees involves a very individualistic approach based on the following factors:
Age and risk tolerance The age of a retiree will determine how long retirement is expected to be and can influence the amount of assets needed for long-term growth. In addition, the retiree’s tolerance for market fluctuation will also help determine the types of investments to be included.
Desire for consumption and bequest The choice between a comfortable retirement and passing wealth on to loved ones can be difficult. The rate of consumption in retirement may impact whether or not a retiree will be able to leave a portfolio behind for their heirs.
Expenses and fees of product choices Ultimately, retirees must weigh the costs of the options before them—including the opportunity costs and the direct costs associated with the products they choose. The fees and expenses associated with different products may make some options cost-prohibitive.
Fortunately, the choices for retirees are not black and white. Based on the factors above, there is an optimal mix of investments and products for every situation.
© 2009 Morningstar, Inc. All rights reserved. 3/1/2009