The Easy Way to Make Your Retirement Savings Last

It's one of the most daunting financial challenges you'll ever face: ensuring that the savings you've built during your career will support you through retirement. But it doesn't have to be that hard, says personal finance commentator Jane Bryant Quinn. In the following excerpt from her new book, How to Make Your Money Last: The Indispensable Retirement Guide, Quinn lays out a three-step plan for financial security after you leave the working world.

This is the fourth book for Quinn—including the bestselling Making the Most of Your Money NOW. She was a columnist for Newsweek and, as part of the Washington Post Writers Group, syndicated in more than 250 newspapers. She also spent a decade at CBS News, where she appeared on the network's morning show and the CBS Evening News with Dan Rather.

In her latest book, Quinn covers everything baby boomers and their heirs need to know about making a nest egg last: from getting the most out of Social Security to buying yourself a pension. Through it all, Quinn preaches simplicity, which is how she handles her own investments. In this excerpt, Quinn explains how to make your retirement portfolio last three decades or more—and even leave something behind for your family.

That will take figuring out how to manage your savings—and choosing the right investments throughout retirement. Here's how to get started.

Pick the Right Withdrawal Rate

The first thing on the road to retirement security is figuring out the answer to this question: How much can you spend from your nest egg every year without eventually going broke?

We're talking about your portfolio—stocks, bonds, mutual funds, certificates of deposit, and so on. The spending rate is your speed limit. It helps ensure that your money will last as long as you do.

Some retirees manage their spending so well that they can live entirely on whatever income they receive from their pensions and Social Security. Most of us, however, will depend partly on our savings to pay our monthly bills. That's why spending rules are so important, even when you don't follow them to the letter. They save you from accidentally using up too much of your money when you first retire.

The classic spending rate is 4% of your total savings in the first year you retire or start drawing on the money. In each following year, take the same amount plus an increase for inflation. Properly invested (more on that later), your money should last at least 30 years. You can start with 4.5% if your portfolio is well diversified.

Those rules have been the gold standard in financial planning ever since they were developed. They would have carried you through the worst periods the U.S. economy has endured, measured from the mid-1920s. For any period better than "the worst," your money should last longer than three decades.

But what if the next 30 years take a different course? That's a question I've asked myself as my husband and I plan for the day when we won't have paychecks. The projected Quinn budget works on a 4.5% withdrawal rate. We want to spend enough to be able to enjoy ourselves yet not so much that we start to worry.

Again, you have to be "properly invested," and that means you can't be afraid of stocks. The research on 4% (and other withdrawal rates, up to 5.5%) assumes you're keeping half your money in blue-chip stocks and the rest in intermediate-term government bonds (in both cases in the form of mutual funds).

That assumption stops some conservative investors cold. (What, 50% in stocks?) Fortunately, you don't have to go that high. The 4% rule still works with only 35% in stocks. If you don't trust the market at all—and buy only fixed-income investments—your safe withdrawal rate goes down to about 2.5%. You can start with 4.5% if your investments include smaller stocks as well as larger ones.

That said, the "safe" 4% withdrawal rate may indeed be too safe. In 97% of the periods studied, retirees wound up—30 years later—with at least the same amount of money they had when they started. If you're flexible in your spending, you could start with as much as 5.5%.

The problem is that you never know. That's why planners generally advise you to start with 4% or 4.5%, take your annual inflation raises, and see where you stand in 10 years or so. If markets have risen, you can increase the draw.

Discover the Joys of "Bucketing"

Once you've figured out a withdrawal rate you're comfortable with, you need to implement a system to help keep track of your investments and risk levels. I recommend a technique known as "bucketing." It suits the way we think.

The idea is to put your money into different buckets, each one reserved for a specific purpose. There's one for cash, one for fixed income (bond funds), and one for growth (stock funds).

The cash bucket is your safety net. It holds enough to help cover your living expenses for two or three years. That doesn't mean all your expenses—only those that won't be paid from other income. For example, say you need $55,000 a year to live, and you and your spouse jointly get $30,000 in Social Security. Your cash bucket has to cover the $25,000 gap, or $50,000 for two years. You dip into it for bills. As the cash runs down, you take profits from your stocks and bonds and fill that bucket up again.

Jonathan Guyton of Cornerstone Wealth Advisors recommends that you add a "discretionary" bucket. That's for the inevitable "wants" that come along. (This is not an emergency fund. It's for the stuff—say, helping a child or taking a special vacation—you break your budget for.) Fund it with 10% of your investment money. When it's gone, it's gone.

Size Up Your Stock and Bond Buckets

Once you have settled on the amount to keep in the cash bucket, next decide how to split the rest of your money between stocks and bonds.

But first repeat after me: After down or "bear" markets, the broad stock market has always recovered. Individual stocks might not, which is why it's so risky to be a stock picker. But the price of a broad-based, blue-chip mutual fund will go back up.

You had an object lesson in 2007 when the financial system almost collapsed. The average S&P stock lost 50% over 24 months. Investors fled. Had you been in the market at its bottom in 2009, you'd have earned back all of your losses by 2012, and then gained another 42% by mid-2015. Unfortunately, no one rings a bell when prices start up. You just gotta be there.

Of course, how much to hold in stocks is a very personal decision. Financial advisers ask you to consider your "tolerance for risk," but that's a poor place to start. Instead, consider your "capacity for risk."

"Capacity" measures whether you can afford the risks you take. If you're a retiree with a pension, Social Security, a paid-up house, and a multimillion-dollar IRA, you have a high capacity. It won't cripple your lifestyle if you're hit with a temporary stock market loss. But if you're living on Social Security plus a small amount of savings, your capacity for risk is zero, no matter how willing you are to gamble.

I don't mean to dismiss risk tolerance. You might have the capacity to keep 90% of your money in stocks but wouldn't dream of doing so. Sometimes retirees choose very low stock allocations because they can't stand the stress.

So how much to allocate to stocks? Typically it's 40% to 65%. You might keep 90% in stocks if you won't need the money and are basically managing it for the next generation. You might put zero in stocks if you're in poor health and your savings are modest.

What's not in stocks and cash goes into bonds. For an allocation that minimizes risk, divide money between high-quality short-term and intermediate-term bond funds.

Short-term funds pay less interest but are pretty stable in price. That makes them useful as a safety net. If stocks are down—and you have to sell an investment—selling short-term bond funds will minimize your loss. (Many planners advise that, between your cash and your short-term bond funds, you hold enough money to protect yourself for four straight years.)

The remainder of your fixed-income money goes into high-quality intermediate-term bond funds, which pay higher rates of interest.

Once you've settled on a stock/bond mix, rebalance every year or so to return to your original allocation or any new mix you choose. As to which of the thousands of mutual funds to buy, you can throw out most of them. The more streamlined your choices, the simpler and surer investment management will be.

Fill Up the Stock Bucket

You hold stocks for growth over 10 or 15 years. You're betting that the U.S. and world economies will have expanded substantially, with corporate profits and stock prices up. It's a good bet.

With dividends reinvested, the Standard & Poor's 500-stock average has never lost money over 15-year periods, and rarely over 10-year periods. Over the 15 years ending in March 2009, which covered the market collapses of 2000, 2008, and 2009, buy-and-hold investors reaped 6.5%. And that's before the 2009–15 recovery. Buy and hold, and history says you'll succeed.

The 4% withdrawal rule assumes your stock performance will roughly match that of the S&P 500. The 4.5% rule assumes you also invest in an index of small stocks. The most reliable way to make this work is to buy index funds, which get the same results as these two markets.

All the funds that follow the same index invest in essentially the same way. The only difference among them is cost. The lowest-cost funds, such as those offered by Vanguard and Fidelity, will provide the best return—and, yes, it's that simple. As long as you buy low-fee index funds and rebalance, your annual withdrawals should last as long as the research says.

Beware: Advisers who earn commissions sneer at index funds. They have a patented method for talking you out of them. "Why would you want average returns?" they ask with a smirk. "Average is for the ordinary schlub."

Before you nod and say, "Yes, please, please take my money now," think what a "market average" means. It has nothing to do with "the middle." It's more like par in golf. Only the best golfers can beat par. The average golfer never does. In the stock market, the index is "par." The miracle of index funds is that they let all investors, regardless of skill, score par all the time.

If, like me, you're leaning toward the 4.5% withdrawal rate, consider buying total market funds. They invest in smaller companies as well as large ones. They've mostly replaced the original S&P 500 funds.

Some advisers suggest you "tilt" your portfolio by adding industry-specific funds that you think might beat the market. Take health care. Health care companies are included in a total market fund, along with companies from other business sectors. If you add a health care fund, you have placed an extra bet on that part of the economy. I don't tilt, myself. I'm not smart enough to know which industry will do the best.

My vote: Hold just one total market stock index fund. Adding different types of stock funds isn't of great importance. Your risks and returns are governed mainly by the total percentage you hold in stocks as opposed to bonds. It takes just one total market U.S. stock fund (for large and small stocks) and one total market U.S. bond fund to make the 4% or 4.5% rules work. (You get international diversification from the big U.S. companies with foreign interests.)

What's In Your Bond Bucket?

Everything in a retirement portfolio has a specific job. For stocks, it's growth. For bonds, it's ballast. All safe withdrawal plans assume your bond funds invest mainly in Treasuries or other government securities, despite low rates. When stocks collapse, Treasury prices usually hold steady or rise. That limits your total loss. By contrast, popular high-yield corporate and tax-exempt bond funds tend to fall along with stocks.

Bond prices are closely linked to changes in interest rates. When rates rise, bond prices fall and vice versa. With interest rates expected to rise, investors today are worried about the value of their funds. But during such periods, bond funds do better than you think.

The managers will invest the fund's cash flow in bonds that pay the higher rates, so the income you receive from the fund goes up. If you're spending it, you'll have more in your pocket. If you're reinvesting it, you'll be purchasing shares at a lower price. When interest rates go down again and bond prices rise, those additional shares will provide you with extra gain.

Please don't panic and switch your money into a bank when rates rise. If you do, three bad things will happen. You'll lose current income because banks often pay less than you earn from bonds. The capital loss that you took on the sale is permanent. And you'll lose the future capital gains that the funds will rack up when the cycle turns and interest rates decline.

As with stocks, it's best to buy bonds in the form of index funds. Need I say that low-cost funds almost always beat the pack? To do better than the index, a managed bond fund has to take higher risks, and why would you want that?

The financial research shows that to succeed with a 4% or 4.5% withdrawal plan, you need only a single high-quality bond fund.

In a tax-deferred retirement account you might choose Vanguard's Total Bond Market Index Fund (VBMFX, which costs 0.20% a year and is primarily invested in government securities) or Fidelity's Spartan U.S. Bond Index Fund (FBIDX, 0.22% and tilting toward corporates). Both are intermediate-term funds that hold short-term bonds too.

With the safety-net bucket approach, add a short-term fund. A high-quality short-term fund falls by only a small amount when rates rise. It also recovers quickly, as the bonds mature and are replaced with new ones paying more. That makes it a potential inflation hedge.

Final Thoughts

I urge you to opt for simplicity. The fewer funds you have, the easier your investments are to manage, especially as you advance in years. Your buckets provide you with cash for withdrawals, bonds for liquidity and reasonable safety over the first part of your retirement, and stocks to help you cover the second half of retirement. All with just two or three index funds. That's it.

Jane Bryant Quinn is a leading commentator on personal finance. Adapted from How to Make Your Money Last: The Indispensable Retirement Guide. Published by arrangement with Simon & Schuster. © 2015 by Quinn Works.