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Sunday, November 27, 2005

 

Income Strategy

There have been many articles that show that high fixed withdrawal rates can exhaust an account prematurely. A simple solution would be to withdraw a fixed percentage (4-5% per year) of the current value of the account. Yes, the amount withdrawn will fluctuate, but that can be managed by controlling volatility of the account by using a balanced approach (e.g., 50/50 to 25/75 stock/bond mix). One problem is that many financial institutions don't allow automatic withdrawals using fixed percentages.

A self managed strategy is to have separate stock and bond accounts to reflect appropriate stock/bond proportion and to set up withdrawals from bond account only. The accounts then are periodically rebalanced to keep target stock/bond proportion.

Bottom line is that income accounts should have low volatility (e.g., low standard deviation, SD).

Assuming stock SD of 20% and bond SD of 4%, 25/75 stock/bond account will have SD of ~ 8.

Total returns are not relevant for income accounts. They are relevant only for accumulation accounts.



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