(Note: Lou was a professor of economics for 30 years. His analysis is based on familiarity with accepted economic principles.)


When we began to think about retirement back in 1998, we had two major financial questions:

    - Will we have enough income when we retire?

    - How should we manage our investments?


In 1998 Joan was nearing 60 and Lou was nearing 65. A quick look at actuarial tables showed us that we'd better plan on having enough money to live 30 more years, so we wouldn't be a financial burden to our daughter. Six years after retirement, we're still in good health, physically fit and enjoying life to the fullest. (2005 photo below: Joan is 65 and Lou 70.)



How would our financial needs change after retirement? Health care and housing were two of the main costs we considered. We had adequate medical insurance. (At age 65, Medicare became our primary insurer and Lou's university insurance provider the secondary insurer.) After looking at the odds of needing it, we decided not to buy too-expensive long-term nursing care insurance. As for housing - we'd need less housing than we did when our daughter lived at home and Joan maintained an art studio there. Downsizing from a house to an apartment or townhouse would be a good option for us.

How would our financial needs change if we didn't stay at home, but traveled extensively? Some things would cost about the same: food, shelter, insurance, taxes, etc. However, if we traveled long-term, we'd also have more transportation costs and health expenses not covered by our insurance (inoculations, anti-malarial medication, etc.) But we found a way to keep travel costs at about the same level as if we stayed at home. For more on this see TRAVEL FINANCES


The typical American retiree receives only 70% of his pre-retirement income. After retirement, we would receive regular income from U.S. Social Security and a university pension, and not-so-regular earnings from our portfolio of investments (stock- and bond-index funds in an IRA and an investment account at Vanguard.) Some people might supplement such sources with income from part-time employment or real estate rental. If we owned a home, we could rent it while we're traveling and hope that (after management fees, property taxes, insurance, maintenance and possible depreciation) the rental and possible appreciation would increase our net income. (Speaking of net income, we'd have to pay for post-retirement living and traveling out of after-taxes income. More on this later.)

All of the dimensions of financial planning for retirement are interconnected. These involve investment planning (annuities, mutual funds, spys and index funds), insurance planning (ordinary life, term life, health and long-term care), trusts and estate planning, and tax considerations (when to draw from sheltered IRA and unsheltered investment accounts, how to minimize estate taxes.)

Prior to retirement we attended a financial planning workshop, then had a free private consultation with the instructor; he reviewed our personal financial situation and gave us plenty of useful information and advice. We knew he'd try to sell us something, as most financial planners are also investment brokers or insurance salesmen, but we firmly resisted his sales pitch.

(In her article, Retirement: How to Land on Your Feet, financial columnist Jane Bryant Quinn advises that you review your overall retirement situation with a financial planner who charges for his or her time - not one who sells products. Newsweek, February 14, 2005.)

We read several books on financial planning and investment - mostly popular writings for lay readers such as The Only Investment Guide You'll Ever Need by Andrew Tobias. From T. Rowe Price www.troweprice.com we obtained Retirement Planning Analyzer - a free kit of three excellent booklets. The firm now provides an on-line Advanced Retirement Calculator: www.myfinancialsoftware.com/per/retirement/overview.htm The first of the three booklets covered inflation and health care, the home as a retirement asset, strategies for retirement plan distributions and social security. The second was a planning workbook that enabled us to estimate, step-by-step, how much we could afford to spend in retirement - taking inflation and taxes into account - without out-living our money. The third booklet explained alternative investment strategies, taking into account the relation between risk and expected return, and the impact of taxes and inflation.


To use this analysis, we had to input a lot of personal information. First, we estimated our past regular annual EXPENDITURES as a benchmark for comparison with projected post-retirement income. We based this estimate on past checkbooks and credit card statements in a recent representative year, leaving out extraordinary expenditures such as college tuition, a new car and house remodeling. To estimate benchmark regular expenditures in the future, we assumed CPI inflation at 4%.

Next, we estimated future INCOME. The easy part was figuring Social Security income and Lou's university pension. (As a self-employed artist and later an "independent contractor" newspaper art critic, Joan has no pension.) Then we took an inventory of our assets in order to estimate the earnings they would generate if they were converted to stock and bond index funds. These were tax-sheltered 403b (like 401k) investments made through Lou's university, and Keogh profit sharing and money purchase plans made through his economic consulting business. All of these tax-sheltered assets were to be rolled over into IRAs. We then totaled our unsheltered assets and estimated the market value of our home which we planned to sell. The proceeds were to be invested in the same index funds.

To estimate income from our total assets, we first set aside a sizable portion of the total asset value as a special emergency fund that might be needed at any time. Then, assuming the remainder of our assets would be converted into stock and bond index funds, we settled on a TARGET MIXTURE OF FUNDS (see next section) that have historically yielded an 8% rate of return. (Such a low future expected rate of return is necessary to keep risk of loss under control.) We summed our 8% earnings from assets with Social Security and Lou's pension, then subtracted federal and state income taxes. We compared this disposable income with our previously calculated regular expenditures inflated at 4% and found that although the income was insufficient to cover our pre-retirement level of expenditures, it would be possible to draw down our estate to make up half of the difference and still have a sizable old-age reserve for Joan at age 92. (If we knew exactly when we would die, we'd spend all of our estate! But we don't know exactly when we'll die, so the purpose of the reserve is to avoid burdening our daughter should we live into our 90s.)

After all this analysis, we were satisfied that we could afford to stop working completely - even though our income after retirement would be less than before.


As an economist, Lou subscribes to the theories of diversification espoused by Nobel Laureates Markowitz and Sharpe, and to the extension of their theory by Fama. According to this theory, BY PROPER DIVERSIFICATION YOU CAN MAXIMIZE YOUR EXPECTED RATE OF RETURN AT ANY GIVEN LEVEL OF RISK. To properly diversify your portfolio, you want to hold a mix of financial assets representative of the world's real assets along with liquid assets sufficient to enable you to sleep at night.

Lou also believes in the "random walk" theory of asset prices, as if these markets are efficient. According to this theory, ON THE AVERAGE, YOU CAN'T BEAT THE MARKET RATE OF RETURN ON ANY GIVEN RISK CLASS OF ASSETS UNLESS YOU (ILLEGALLY) USE INSIDE INFORMATION - OR ARE LUCKY.  It follows that you can't systematically gain by relying on either a personal broker or a regular mutual fund manager to choose or change your portfolio. In fact, you will lose on the average because they'll charge you for their management services.

Our use of these theories resulted in a portfolio comprised exclusively of INDEX MUTUAL FUNDS at Vanguard - which has the largest selection of index mutual funds and provides all the services we need. (A share of an index mutual fund is like the sum of a tiny share of each company in a class of companies in proportion to its size. For example, if a share of the U.S. large cap growth index fund has a market value of $100, the component parts of that value might be $.70 IBM, $.40 Ford Motor, etc.) 

Because we hold indexes, there is essentially no managerial fee and, in the absence of management transactions, there are minimum income taxes. Our TARGET MIX OF STOCK INDEX FUNDS (an approximation of the world's real assets) was as follows:

        20%    U.S. large cap growth

        20%    U.S. small cap growth

        20%    U.S. large cap value

        20%    U.S. small cap value

        12%    European

         8%    Pacific

TO CONTROL RISK we wanted to hold only 65% of the portfolio in stock index funds, with the remaining 35% in a highly liquid short-term Treasury bond index fund, which is almost as safe as cash.  We chose this TARGET MIX because the expected rate of return was an acceptable 8% and we didn't want to expose our portfolio to more risk of stock fund failure. We don't need a higher percentage in bond index funds for income, because much of our regular income comes from Social Security and pension checks. We don't want a lower percentage of bond index funds, because we may want to make a down-payment on a condo in a few years.

When we sold our Hawaii house, we purchased the safe bond index fund with most of the proceeds. The result was an initial mix of more bond index than stock index funds - nowhere near our target. We therefore instructed Vanguard to carry out a monthly DOLLAR-COST-AVERAGING reallocation of some bond index fund shares to stock index funds. The plan was to move gradually, month-by-month, towards the target mix over five years. (This goal was achieved on schedule by the time Lou was 70.) In the next few years the target will change to something more conservative and we will gradually increase the percentage in bond index.

The Vanguard account actually has two parts. One is a tax-sheltered IRA, the other an unsheltered investment account. Some of our stock indexes (such as large cap value indexes) tend to yield dividends which are taxable at relatively high rates. Others (such as small cap growth indexes) tend to yield capital gains which are taxable at lower rates. To minimize overall taxes, we tend to protect the large cap value indexes by keeping them in the tax-sheltered IRA, and expose the small cap growth indexes to taxation by keeping them in the unsheltered investment account.

It took a lot of effort to consolidate all of our assets in these two accounts at Vanguard. Now that the work is finished, our financial life is well-structured and simple. We sleep soundly at night, knowing we did our homework. Once a year we take any capital losses for tax purposes and review the mix of funds, making any adjustments necessary to keep the mix approximately optimal.

Have we gotten rich? Definitely not! During the first five years, we endured a stock market crash, followed by 9/11 and its aftermath. Although we haven't made our 8% expected return, we also haven't lost our shirts. In fact, we've stayed a couple of percentage points ahead of inflation and income taxes.


With hindsight, of course, we could have gotten rich if we'd invested in certain companies' stocks or in real estate in certain locations. Over the past five years, some of our friends in California have seen the value of their homes increase much more rapidly than our portfolio. Of course, it's impossible to pick the winners in advance, isn't it? If interest rates continue to rise, the California real estate bubble may well burst in the next couple of years. All you can intelligently do is maximize your expected return for a given level of risk. If you're lucky, your actual return will be greater than the expected return for a given level of risk; and if you're unlucky, your actual return will be less. If you lose with the plan we've outlined, at least your losses will be controlled by diversification.

Now for a more cheerful subject - how to spend all the money you've spent a lifetime earning. We suggest that you use some of it to discover the world! See TRAVEL FINANCES




Joan and Lou Rose     joanandlou@ramblingroses.net