In his usual lucid style, Jonathan Clements discussed how market cycles affect the longevity of a retirement portfolio in last week’s Getting Going column ("Playing the Right Retirement Cards," The Wall Street Journal, Nov. 16, 1999.)

Market swings average out while you are building your portfolio. Indeed, market swings make your portfolio grow faster if you have the fortitude to invest steadily or to "dollar cost average." Consequently, it is a fair approximation to assume a constant rate of market return when forecasting the long term appreciation of your portfolio prior to retirement.

However, ignoring market swings is dangerous when forecasting after retirement when you will be taking money out of the market. If the market moves above the long term trend after you begin withdrawals, the constant return assumption tends to underestimate your financial security even if a serious market upset down the road brings the market back to the long term trend. In contrast, a constant market return tends to overestimate your financial security should the market decline soon after you retire, even if the market later recovers.

A serious decline when you begin taking money out can put your portfolio so far in the red that even years of subsequent good performance won’t make your portfolio whole again. Therefore, it is prudent to consider the possibility of a serious decline shortly after retirement when making retirement forecasts.

Since the late 1920s, the long term trend in US stock market has been to increase about 7% a year faster than inflation. If this trend were to continue steadily, you would be able to withdraw 8% from your portfolio each year (pre-tax, adjusted for inflation) for thirty years.

Two serious portfolio declines this century, the market crash in the 1930s and the inflation crash in the 1970s, would have made it impossible to sustain an 8% withdrawal rate. Mr. Clements concludes that someone contemplating a thirty year retirement ought to opt for a 4% withdrawal rate, or only one half of what would be possible in the absence of market cycles, if they want to reduce the risk of running out of money to a tolerable level. (See also the T. Rowe Price’s Fall 1999 newsletter at www.troweprice.com/viewpoint/pr99fall.pdf.)

Four percent pre-tax is consistent with my own projections for a newly retired sixty year old. (See "How Withdrawals Affect Your Risk of Running Out of Money Before You Run Out of Breath" at www.lingane.com/tax/risk.htm#part2.)

The Clements’ article also confirms my conclusion that the risk of running out of money does not increase if you add bonds to the portfolio, so long as you do not exceed about 50% bonds. The conservative investor can therefore reduce volatility by adding bonds without increasing their risk of running out of money. The price paid for the reduced volatility is a reduced benefit for the heirs.

Mr. Clements concludes his discussion "The best approach may be to adopt a riskier strategy, knowing that you can throttle back your spending if the markets turn against you." I disagree. My historical simulations suggest that taking less when the market goes down generally fails to stabilize the portfolio decline.

If the historical record convinces you to plan for a 4% withdrawal rate during retirement, you should consider Treasury Inflation Protected Securities as an alternative to a stock and bond portfolio. ("TIPS" are further discussed in "The Case For Inflation Indexed Bonds" at www.lingane.com/tax/tips.pdf.)

• The US government guarantees the 4% withdrawal rate for thirty years with no loss of purchasing power. There is no such guarantee with a stock and bond portfolio.
• You receive your original investment back at the end of thirty years, adjusted for inflation, whereas a stock and bond portfolio might be exhausted well before thirty years. The flip side is that your heirs will receive more with a stock and bond portfolio if the market avoids a serious downturn early in your retirement years.
• TIPS are substantially less volatile than is a portfolio of stocks and bonds because the government has assumed the inflation risk.