To get a rough budget, you'll need to estimate your overall expenses, your sources of income, and how long you need your income to last. The method outlined here is meant to be a first step, an approximation. It will help you judge whether your income may enable you to reach your main goals. It won't answer every question, down to the last dollar. But it's a good start.

Here's an overview of the method, step-by-step. It has five "round numbers" that are close enough for a rough budget.

1. Find Life+6, your life expectancy plus an extra cushion of six years.
2. Use tax returns and account statements from last year, plus the inflation rate for the past 12 months, to estimate your annual expenses this year. This number is what you actually spent last year, including tax payments, but excluding income you saved, all adjusted for current inflation.
3. Find your stable income from Social Security, pensions, income annuities, and reliable work, also adjusted for current inflation. Life+6 plays a part in calculating this number.
4. If your stable income won't cover your annual expenses, find your spending balance. This is the amount available to extract from your spending account. As detailed in Enable Your Accounts, a spending account is a temporary reserve where you manage one or two years of living expenses.
5. If your annual expenses are still not met, calculate the safe payout you can take from your retirement accounts and taxable savings. With Life+6, there's a simple, reasonable way to do this calculation. (Our Safe-Payout calculator does it for you, and offers other options, as well.)

Should you be over 70 years and 6 months of age, and required by the IRS to take minimum distributions from your retirement accounts, these would go to your spending account in step 4, if needed, and next to your safe payout or taxable savings in step 5.

For worked examples of each step, click here to read the full article.

This post was part of a series on building a portfolio of mutual funds or Exchange Traded Funds. Much of the series has been moved to articles on the Portfolios menu:

• Basic Portfolios: Some simple ideas that work remarkably well.
• Diversify: Effective ways to diversify with bonds and stocks, globally.
• Factor Investing: Specialized portfolios that employ techniques from academic research.
• Respond to Inflation: Realistic options for inflation-protection, near-term and long-term. (Not yet moved, this topic is covered below, in this post.

On the topic of inflation, Andrew Ang's fine textbook, Asset Management, offers many good insights, to which I am much indebted (see his chapter 11). I've superimposed my own analysis, however, and sometimes relied on additional sources.

It's helpful, I think, to focus on inflation with three sets of questions:

• Near-term: At a given time and for the next year or two, how should an investor's portfolio adapt to inflation or, equally important, to deflation? This question matters if, and only if, you plan to spend some of your investments in the next year or two.
• Long-term: What investments, if held a long time, will best protect against inflation? Do the same investments protect against deflation? And how long is long enough?
• Correlates: Both near-term and long-term, what investments (if any) are correlated with inflation (or deflation)? If one applies diversification criteria, do any of the popular candidates, such as TIPS, commodities, and real estate, truly add value?

An important conclusion will be that sensible protection against inflation and deflation is possible, but by different methods for the near-term than for the long-term. Furthermore, the popular candidates may not be the best or the only methods you should consider.

Here's an interesting test. You come to me in December, asking "What will inflation be next year?" I caution that nobody knows the perfect answer, but one indicator is quite good and amazingly simple. "It has correlated 0.64 with next year's inflation for the past 100 years," I proclaim. Then I show you data for the past century, using the chart below. Can you guess what my indicator is?

No, it's not the price of oil or gold. It's not the return on inflation-indexed bonds, or the median price of homes, or any exotic financial product. And it's a lot simpler than the economic model favored by this year's hot economist. It's last year's inflation. Yup. Next year's inflation is pretty well predicted by inflation over the most recent 12 months. That's because inflation (or lack of it) tends to persist. *

Despite the dire tone of some articles and commentary, inflation is not like a thief in the night who steals your heirloom jewelry, sets your home ablaze, and swiftly vanishes before dawn, leaving your wealth devastated. He's more like the unwelcome guest, your financially reckless cousin, who emails you one day and shows up on your couch the next, feasts from your pantry, maxes all your credit accounts, totals your car, and requires strenuous measures to be evicted, leaving you poor, thin, weary, and forgiveably ungracious after a prolonged ordeal.

The point is that you'll know when inflation is becoming a problem. One of the more obvious clues will be that interest rates are rising. That clue, as it happens, also defines your best defense.

T-Bills
As Ang and others before him have pointed out, the asset most strongly correlated with inflation and the best single hedge against it is a 3-month Treasury Bill. As inflation rises or falls, the interest rate on T-Bills tends to follow. Because T-Bills can be redeemed and reinvested at the newest rate every three months, the response to inflation, although lagging somewhat, is timely. 

Even so, it's not a perfect hedge, mainly because policies of the Federal Reserve sometimes (not always!) hold T-Bill rates below the inflation rate. That happened for nearly two decades during the Great Depression and World War II, and again, more recently, for six years and still counting since the financial panic of 2008-2009.

These limitations notwithstanding, a T-Bill offers good protection against inflation for expenses you know you will have to pay within the next year or so. Here's a concrete example:

• A hypothetical saver needs $1000 per month to pay expenses that are not covered by her other sources of income, such as work, Social Security, or an annuity.
• In late December, she has $3000 in a bank account (earning next to nothing) to cover her expenses through March. She withdraws $12,000 from her investment or retirement account, and buys a 3-month T-Bill. (She can do so easily and with no fees whatsoever at www.treasurydirect.gov.)
• In April, she redeems the T-Bill and puts enough in her bank account to cover the next three months' expenses. If her expenses have risen (or fallen) a bit in the past three months, she sensibly increases (or decreases) the amount set aside in her bank account, thus maintaining a smooth standard of living. (To simulate these adjustments, I exactly matched them to the change in consumer prices, up or down, for the previous quarter.) The remainder gets reinvested in a new 3-month T-Bill.
• She does the same in July and October.
• At the end of December, she looks at the amount she will get by redeeming the most recent T-Bill, to see if it will cover the first three months of the coming year. She wants it to cover her real expenses, which may have risen above $1000 per month because of inflation over the past year.

Had this strategy been followed every year from 1934 to 2014, the results would have been as shown in the chart below. The value depicted in the chart is the surplus (or deficit) over the amount needed for the first quarter of the coming year, adjusted for inflation.

Before 1952, when interest rates were restrained by the federal government, the results were weak. On average, the amount available after a year was nearly 9% less than the amount needed for the next three months. These were desperate times, financially, and it is not clear that any one-year savings plan could have done better.

From 1952 through 2014, the results were good. On average, there was a real 1% surplus, and surpluses occurred much more often than deficits. On the assumption that future federal policies may resemble those enforced since the early 1950's, the T-Bill strategy looks attractive.

Short-Term Treasuries
What if you were willing to take a bit of a chance on longer-term bonds? For example, how about a short-term Treasury fund whose bonds have average maturities around 2 years? One might expect such a fund to respond to inflation less quickly than T-Bills, but to pay a higher rate of interest and to be penalized somewhat less when federal policies suppress the interest on T-Bills. The next chart shows the results from using 2-year Treasuries instead of 3-month T-Bills.

Clearly, there is much more variation from year to year, which is not good for budgeting. On the other hand, the average surplus for the period 1952-2014 was higher, around 2%. In several years, the surplus was a full month's expenses. Here's an idea: What if the surpluses were carried over, to offset subsequent deficits?

A variant of that idea turns out to be highly effective, perhaps the best strategy of all. It works like this:

• In the first year, save two years' expenses ($24,000 for our hypothetical saver) instead of one ($12,000).
• Use a fund of 2-year Treasuries instead of T-Bills.
• Don't spend any surplus. Don't try to replenish any deficit. Simply add next year's expenses at the end of each year, adjusted according to the past year's inflation, exactly as in the T-Bill strategy.

The extra deposit at the outset serves as a cushion, creating, in effect, a reserve fund.

This strategy accumulates unspent surpluses over time, even in difficult periods. The chart above illustrates how the strategy would have worked in three very different 26-year periods. The first period, 1934-1959, saw a toxic mix of occasional high inflation, recessions with steep deflation, and persistent suppression of Treasury rates. During this time, the strategy lost some of its reserves but never went to ground. Bear in mind that the values in the chart are real dollars (inflation adjusted). Thus, the $3000 of buying power that remained on reserve at the end of 1959 would have seemed much larger in nominal dollars. The second period, 1961-1986, spanned multiple recessions and successive years of high inflation. Yet it maintained good reserves throughout. The final period, 1988-2013, benefited from a bull market in Treasuries and ended with enough surplus to cover more than two years of inflation-adjusted expenses.

Short-Term TIPS
Originally, they were called Treasury Inflation-Protected Securities, or TIPS. But they never truly guaranteed protection from inflation, and the Treasury Department now calls them Treasury Inflation Indexed Notes or TIINs, if their maturity is five years. The new name is apt because in recent times, their value as an inflation hedge has been about as good as, well, TIIN.

Surprised? Consider this example. In October 2010, you could have bought TIPS from the Treasury Department that would mature four years and eight months later, in April 2015. Those TIPS would have paid a measly interest rate of 0.5%, which would have seemed reasonable because T-Bills paid even less. At the time, the big institutions that bid at Treasury auctions expected inflation to start rising. So they bid up the price of the TIPS, thereby forcing buyers to pay, on average, $1055 for a bond that could be redeemed in nearly five years for $1000 plus inflation. They were counting on inflation to recoup the extra $55 and then some. As it all worked out, the cumulative inflation between October 2010 and April 2015 was 8.2% (equivalent to 1.7% per year). The buyer was therefore paid about $1082 in April 2015, plus those flimsy interest payments twice a year. For the initial investment of $1055, the buyer got a real (inflation adjusted) total return of about 1% per year. The five-year bet on inflation paid off, in this case.

But what if the original buyers' expectations were wrong? It can happen. In July 2014, no one anticipated that inflation for the next 12 months would be virtually zero, but that's what it was (0.2%). If you had bid on TIPS in early 2014 expecting a 1% real return, you would be holding a loss after the first year. Because mutual funds and ETFs buy, sell, and redeem TIPS continuously, they are vulnerable to such miscalculations. They can lose money when their inflation bets are too high. 

For some evidence, consider the chart below. It shows the real (inflation-adjusted) returns since late 2009 for two funds: STPZ, the PIMCO ETF for short-term TIPS; and VSGBX, a Vanguard fund for short-term bonds from the Treasury Department and other federal agencies. The PIMCO fund holds TIPS exclusively; the Vanguard fund holds no TIPS at all. Over the six-year period, both funds virtually matched inflation, with a terminal value near $1.00 for every dollar originally invested. But the TIPS fund was more volatile, rising or falling as its inflation bets came out winners or losers.

It would be nice to know if the long-term trend will resemble the short history shown in this chart. Alas, six years is the longest history available for a short-term TIPS fund as of September 2015. Pending additional evidence, a rational investor could use a short-term TIPS fund, instead of short-term Treasuries, but the outcome might not be any better, and the ride may be less smooth. An educated guess is that short-term TIPS may do better when inflation is rising, while short-term Treasuries might excel when deflation and recession are lurking.

Academic studies and historical data imply that near-term protection against inflation (and deflation) can be secured by either of these strategies:

• Hold a year's worth of anticipated expenses in 3-month T-Bills, redeeming and re-investing every three months. Virtually as good, use a savings or money-market fund if it is safe, very liquid, and pays interest at or above the rate of T-Bills.
• Or, hold two years of anticipated expenses in a fund of short-term U.S. government bonds. Withdraw expenses for a year, and replenish with anticipated expenses for the next year, keeping any surplus on reserve. A fund of short-term TIPS may be reasonable, but other U.S. government bonds are likely to offer more consistent performance.

In the next and final post in this series, we'll look at long-run inflation and the best strategies to mitigate its effects on your portfolio.

* In the chart, an outlier that goes against the trend is the solitary point in the lower right quadrant. It's for 1921 when, after World War I brought inflation that exceeded 15% annually, the economy sank sharply into recession. Within the year, high inflation switched to extreme deflation. It's the only such whipsaw in the past century. In fact, it's an exception that proves the rule because the preceding inflationary trend persisted for four years, and the subsequent deflation lasted for two, followed by several years of low inflation and the booming economy of the Roaring Twenties.

Disclaimer: Historical data cannot guarantee future results. Although a mixture of bonds and stocks may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, or type of insurance.

This post is part of a series on building a portfolio of mutual funds or Exchange Traded Funds. The topics of the series, listed below, have been expanded into a downloadable handbook at Enable!, our online bookstore. The download includes new content on account types, sample portfolios, technical methods, and more.

• Start with Basics: Some simple ideas that work remarkably well.
• Diversify Smartly: Effective ways to diversify with bonds and stocks, globally.
• Focus on Factors: Specialized portfolios that employ techniques from academic research.
• Respond to Inflation: Realistic options for inflation-protection, near-term and long-term.

Bonds may seem simple. But they aren’t. To explain how they might diversify a portfolio, I’ll start with a common-sense overview, then give some basic recommendations for U.S. bonds. After that, if you want details and justifications, you can optionally read to the end of this post. International bonds are covered in a separate post.

You buy bonds, they pay interest until they mature, then you get your original deposit back. Almost like CDs, right?

Well, not exactly. With bonds, the price goes up or down as the prevailing interest rates go down or up. It’s backwards. Rising interest rates mean falling values for the bonds in your portfolio, and vice versa.

Plus this. With bonds, unlike CDs, you have to worry whether the bond-issuer will default, stop paying the interest you are due, and maybe return less than your original purchase amount. Treasury bonds, issued by the U.S. government, are the least likely to default, hence the safest. Corporate bonds have a higher risk of default, particularly from low-rated companies.

Foreign bonds, anyone? If they are issued by, say, the United Kingdom or Japan, the risk of default is probably very low. But there’s a catch. You have to buy the bonds in British pounds or Japanese yen and convert the interest-payments to dollars.  You have become a currency gambler.

Then there’s inflation. If it goes up (or down), interest rates will tend to rise (or fall), but not immediately, and your bond values go the other way (eventually). What’s more, there’s presumed inflation, the rise or fall that bond-investors expect to occur. This expectation affects bond-prices, too. And guess what? The expectations may be wrong (because inflation is hard to predict). Even if the expectation is right, and inflation perks up as forecasted, long-term interest rates are likely to respond later and less than short-term ones. All of which makes bond-pricing and inflation-watching a real puzzler.

Try to figure this one out: You thought inflation rates would rise, followed in a few months by rising interest rates, after which the U.S. economy would slow down to what economists once called a “soft landing,” and a mild recession would then grip the globe. As events unfolded, interest rates did rise, but inflation failed to follow, and every economy worldwide tanked more than forecasted, causing some indebted companies and weak governments to default. What happened to your bond portfolio?

Give up? Some investment firms do essentially that, opting for the easy recommendation to buy a portfolio that covers the “total bond market.” Examples: VBMFX plus VTIBX from Vanguard; or AGG plus IGOV from iShares; or ETF combinations weighted to mimic the world’s bond markets, as done at Betterment, Schwab, and others. (Actually, these are “near-total” funds as they rightly exclude junk-bonds from low-rated companies and tax-advantaged bonds from city and state government.)

The following recommendations are based on academic research as reviewed in a fine textbook by Andrew Ang, and on my own detailed analysis of U.S. Treasury and corporate bonds from 1953 to 2015. This historical period had three very different, 20-year phases. The first saw rising interest rates; the second had high inflation coupled with rates that rose then started to fall; and the last enjoyed steadily falling rates. Beware of advice based exclusively on any newer, shorter time period. Most questionable are recommendations from data that starts after 1982. That's an exuberant period of falling interest rates, rising bond prices, and low inflation overall, which was biased in favor of bonds.

My analysis of the longer period from 1953 to 2015 suggests that three bond funds can diversify your stock investments. At any given time, one or two of them will suffice, depending on your circumstances.

• Long -Term U.S. Government. The fund should invest in bonds from the U.S. Treasury and other federal agencies, with average maturities longer than 10 years, preferably near 20. Examples: VUSTX or VGLT from Vanguard, or TLH or TLT from iShares. 
• Long-Term Corporate. The fund should hold 10-to-30 year bonds issued by well-rated (investment-grade) U.S. companies. Examples: VWESX or VCLT from Vanguard, or LQD from i-Shares.
• Short-Term U.S. Government. In this fund you should find Treasuries and bonds from other federal agencies, with average maturities of 2 to 3 years. Examples: VSGBX, VGSH, or VFISX from Vanguard, or SHV from iShares.

(In a taxable account, you should consult your tax-adviser about using a short-term or long-term municipal bond fund, perhaps for your state, instead of the funds listed above.)

To determine which fund to use, if you plan to hold your investments for five years or longer, consult the table below. For example, when Able to Pay's calculator (or some other method) says you should invest 70% in stocks, then the table advises you to put the remaining 30% in long-term government bonds. But if your stock-allocation is below 40%, the table assigns the rest to long-term corporates. The 40% threshold is not absolute. You could reasonably use an even split of long-term government and corporate bonds for stock-allocations near 40%.

For holding periods of one to five years, two changes should occur. Your stock-allocation should decrease, to reduce the risk of loss. Concurrently, your bond-holdings should shift toward short-term government issues, both to control losses and to respond, if necessary, to inflation.

The next table lays out guidelines for a forward-looking, middle-of-the-road investor, one who aims both to achieve some gains and to limit possible losses, and who plans to spend 100% of her savings one to five years from now. Consistent with the preceding table, long-term bonds are allocated to corporates if the overall stock-allocation is under 40%; otherwise, the long-term portion goes to government-issued bonds. One could do about equally well by putting bonds in an intermediate-term index, such as a "total bond market" fund, when the stock percentage is below 40% and the holding period is five years or less.

For values fine-tuned to your preferences and circumstances, use Able to Pay’s calculators, which take into account two aspects of your holding period: when you will start spending, and how many years you will continue spending. The best allocations for you may be different from the tables above if your spending starts farther in the future or lasts more than five years. And bear in mind that any funds you need to spend within 12 months (a zero-year holding period) should be kept in bank savings, T-Bills, or a money-market fund.

These are the basic recommendations. To get the full details, read on!

To develop recommendations for corporate and long-term bonds, I began by asking whether various bonds could beneficially diversify a portfolio that already held U.S. stocks. This analysis entailed a new concept, investment factors. Where macro-factors apply to big forces that affect an entire economy or many markets, an investment factor is more narrow. It affects the investments in a particular market.

Academic research has identified several investment factors affecting bonds. The two most important, for our purposes, are term structure and credit risk.

• Term refers to the number of years a bond pays interest (its years to maturity). Short-term bonds have maturities less than 5 years; intermediate-term bonds, 5-10 years; long-term bonds, 10-30 years. As Ang’s book explains (chapter 9, section 3.3), the interest rates of short-term bonds are heavily influenced (about 70%) by inflation; they are much less influenced by economic growth, monetary policies, and other macro-factors. For long-term bonds, the opposite holds true. They are weakly influenced by inflation (32%) and strongly influenced by other factors. The influences on intermediate-term bonds are much like those for long-term bonds. It may be promising, therefore, to diversify between short-term and long-term bonds, omitting or de-emphasizing the intermediate term.

• Credit refers to the risk of default. Will the issuer of the bond make good on the promise to pay dividends and to return all the principal (the face value) when the bond matures? With U.S. Treasuries, the risk of default is extremely low, and is often assumed to be zero. In contrast, bonds issued by corporations (and government agencies other than the U.S. Treasury) have some risk of default. Investors who held bonds from General Motors in 2009, for example, or from the City of Detroit a few years later, faced the very real risk of not being repaid the full amount they had invested. Credit risk can be mitigated by buying bonds from many issuers, just as the risk of bankruptcy can be mitigated for stocks by purchasing shares in many companies. Because corporate bonds have credit risk and U.S. Treasuries do not, diversifying across the pair of them may be advantageous.

Taking guidance from the investment factors of term and credit, let’s apply the diversification criteria to short-, intermediate-, and long-term Treasuries and corporates.

• Are they objectively different? When contrasted with stocks, corporate bonds depend on the financial health of the companies, as stocks do. Treasuries don’t. They depend, instead, on the good faith and credit of the U.S. government. Thus, Treasuries should get more weight as diversifiers, because they differ from stocks to a greater extent than corporate bonds do. Among bonds, the biggest differences are between short-term Treasuries and long-term corporates, as they differ on both factors. Perhaps these two will diversify each other, while they also diversify stocks.
• Are there new risks? Technically, the credit risk of a company’s bonds is somewhat less than the risk of loss from investing in the same company’s stock. Why? Because if the company fails, bond-holders may partially recoup their investments, while stock-holders lose everything. Because of this, and because the default-risk of U.S. Treasuries is extremely low, the incremental risk of adding any bonds to a portfolio is minimal. That’s good for diversification! (A caveat: Low-rated bonds, which have high credit-risk, may add little value.)
• Are the returns equal or better? No. In general, the returns on bonds are less than on stocks. However, long-term bonds come closest to the compound return of stocks, thus arguing for them as the best of a set of tepid choices.
• What’s the correlation? Historically, the correlation between Treasuries and stocks has tended to be zero or somewhat negative, making Treasuries attractive diversifiers for a stock-portfolio. Corporate bonds tend to have low positive correlations with stocks, low enough to make them candidates for diversification, but less compelling than Treasuries.

Clearly, no single type of bond scores highly on all the diversification criteria. A mix of Treasuries and corporates looks promising, because it would diversify across the credit factor, but the mix must also diversify across term. To find a good mix, I analyzed portfolios ranging from 10% to 90% in S&P 500 stocks, and the remainder in a single type of bonds. I did so for data from 1953 to mid-2015, for each of the following: 

• 2 Year Treasuries (short-term)
• 5 Year Treasuries (intermediate-term)
• 10 Year Treasuries (intermediate-term)
• 20 Year Treasuries (long-term)
• 20-30 Year A-Rated Corporates (long-term, with favorable credit-risk)
• Simulated Intermediate-Term Index*

The chart above shows the results, applying the same investment goals used earlier in this series. For building real wealth and keeping pace with inflation, long-term bonds, both Treasuries and corporates, best diversified a portfolio that already had stocks. They generated the biggest portfolio returns. For limiting downside volatility, however, 2-year Treasuries were the best addition, because they had the smallest portfolio losses. In comparison, intermediate 5- and 10-year Treasuries and a simulated intermediate-term index were middling, neither best nor worst.

This finding poses a dilemma. Is it possible to add both long-term bonds and short-term Treasuries without nullifying their respective benefits? Or does one cancel the other, making the combination no more effective than simply using intermediate-term bonds, perhaps chosen broadly to represent the entire bond market? The solution to the dilemma turns on your goals as an investor.

Long-Run Goals
Continuing with the same broad goals used earlier in this series, let’s first consider investments you plan to hold longer than five years. For these, your weights would be:

• Grow wealth: High
• Protect buying power: High
• Avoid losses, near-term: Low

With many years left before you spend your investments, you could ride out near-term losses, provided that your portfolio’s long-term trend was to grow faster than inflation and also, if possible, faster than the economy. In this case, your portfolio should have 40% to 90% invested in stocks, by our models, with the specific percentage depending on your spending plans and tolerance for market swings. The rest of your portfolio should be in long-term government-issues, because they exhibit no correlation with stocks, historically, and their low risk of default differentiates them from economically vulnerable corporate securities.

The evidence is in the chart above. It is like the previous chart, but limited to portfolios with 40% or more invested in stocks.** In the top two panels, which correspond to the high-weighted goals, notice the bump-out for 20-year Treasuries. Even for the lower-weighted goal of limiting near-term losses, in the bottom panel, 20-year Treasuries did virtually as well as most other bonds, for these long-run portfolios.

The advantage of 20-year Treasuries was consistent. They ranked first or a very close second at all stock-allocation levels from 40% to 90%. That said, they were not necessarily tops in any given year, and the paths taken through particular 20-year periods were variable.

What if you prefer to invest less in stocks for the long run than our models recommend? In that case, at stock allocations from 10% to 30%, long-term corporates would have been your best diversifier, historically. This makes sense intuitively because a smaller allocation to economically sensitive stocks encourages a modest exposure to the credit risk of corporate bonds. The next chart has the evidence. Now the bump-out in the top two panels is for long-term corporates.

Near-Term Goals
Bear in mind that the foregoing results are for holding stocks and long-term bonds for many years. What if you hold them for shorter periods? Then your goals are different, something like this:

• Grow wealth: Low
• Protect buying power: High
• Avoid losses, near-term: High

As implemented in our calculators, if you plan to spend your investments over the next one to five years, a portion of your portfolio gets transferred from stocks to bonds. The transfer goes increasingly to safer, short-term government bonds as you get closer to the year when you will start spending. But they don't go there completely. Some bonds remain in longer-term securities. Should those be long-term corporates, as argued above, or something more cautious?

The next chart answers the question with two good options. It displays average results over all of the 20 unique combinations generated by our calculators where the holding period is five years or less and the recommended allocation to stocks is under 40%.

Yes, keeping the remainder in long-term corporates is a good option. Virtually as good, however, is assigning the rest to a fund that indexes intermediate-term corporate and government bonds (“total bond market” funds, for example). The real return is slightly worse with the intermediate option, but the risk of loss compensates with a marginally better reading, and this is the more important goal. All in all, both choices work well.

Long-Run Example
Recall that the historical data covered three 20-year periods during which bonds performed very differently. Using the previous example of a long-run portfolio with 66% in stocks (the S&P 500), the following chart illustrates what happened in each period when the the remaining 34% went to long-term Treasuries. The journeys were disparate, but the outcomes, very similar.

Near-Term Example
Previously, when looking at basic portfolios, we examined non-overlapping, three-year holding periods for investments cautiously allocated 25% to S&P 500 stocks, 20% to 10-year Treasuries, and 55% to 2-year Treasuries. Let's take a fresh look at those periods, with these updates:

• Long-term corporates replace 10-year Treasuries.
• The investor, using Able to Pay's calculators in the intended manner, updates allocations annually as the years ramp down from three remaining to two and then to one. By the final year, the allocations are 10% S&P 500 stocks, 10% long-term corporates, and 80% 2-year Treasuries.
• Instead of periodic rebalancing, the portfolio is simply set to its new allocations at the end of each year.

The outcomes, shown in the chart below, are somewhat more consistent (less dispersed at the end), and the losses are smaller in the two worst cases, 1972-1974 and 1978-1980. An apt way to summarize the pattern is that for an investor whose goal is to minimize losses, this ramp-down strategy for bond-allocations resulted in a low 10% chance of losing 10% in buying power over three years. (And nominal dollars, not adjusted for inflation, exhibited no loss at all in any of these time periods.)

* The Simulated Intermediate-Term Index was a weighted average of 10% 2-year Treasuries, 50% 10-year Treasuries, and 40% 20-30 year corporates. This value had virtually the same compound return and standard deviation as Vanguard's Intermediate Bond Index fund since it was initiated in 1994. 
** While 40% was chosen as a threshold because of Able to Pay’s model for long-run portfolios (held five years or longer), it was optimal by another criterion, as well. In a linear regression seeking to optimize returns, 40% was the point above which 20-year government bonds emerged as the best long-term diversifiers. Below 40%, long-term corporates were better.

Data sources: Shiller for S&P500, 10-Year Treasuries, and CPI inflation. FRED for 2-year, 5-year, and 20-year Treasuries, and A-rated long-term corporates; some missing data-points were interpolated with regression models. BEA for real GDP annually in the U.S. For those interested in technical details, a forthcoming article to be published at this site will explain how the measurements here were constructed and compare them to other possible methods of analysis.

Disclaimer: Historical data cannot guarantee future results. Although a mixture of bonds and stocks may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, or type of insurance.

An annuity that gives you guaranteed payments, for the rest of your life, may seem attractive. But it likely comes with fees and restrictions that may be hard to decipher. Furthermore, the net benefit to you may be less than you think, and more expensive than other options. Still, for some, certain annuities make sense. The key questions are:

• What's an annuity, and do you need one?
• How can you find the best annuities from the best companies?
• What annuities should be avoided, because better alternatives are available?

For answers, click here to read our article on annuities, which is located on the Retirement tab. Or, for detailed examples based on our research, continue reading the post below.

Here are some examples of Single-Premium Immediate Annuities (SPIAs) and other options. They are based on actual quotes and real products, for a hypothetical married couple in their late 60's, seeking to invest $100,000 from an existing retirement account, with 100% benefits to be paid as long as either spouse lives. Although the quotes and products are genuine, I've made the companies anonymous because they may not operate in the state where you live, your age and other variables may differ, and the companies may impose contractual stipulations that depart from the quotes and website-data available to me. These examples should not be construed as recommendations to buy any particular security or insurance product. Rather, they are intended to illustrate how you might examine and evaluate annuity options applicable in your circumstances.

• SPIA-3%. This immediate income annuity raises its payments by 3% each year. The first year's payment is $4544, a 4.54% rate on the $100,000 deposit. With a COMDEX rank of 96, the insurer is among the top 30.
• SPIA-CPI. Also an immediate income annuity, this one increases its payments by the same percentage as the previous year's increase in the Consumer Price Index. Its first year payment is $4349, or 4.34%. The insurance company's COMDEX rank is 90, which puts it solidly in the top 100.
• Rider. This variable annuity is a partnership between a well established, highly regarded investment firm and an insurance company with a COMDEX rank of 92 (the top 60). Underlying the annuity is a mutual fund invested 60% in domestic and international stocks, and 40% in domestic and international bonds. The mutual fund, if purchased by itself, would have fees under 0.2%. Purchased as a variable annuity, it has additional fees of 0.29%. A guaranteed income rider adds 1.2% more. The total fees are pro-rated as 0.127% deducted automatically every month. In year one, for a $100,000 purchase, the annuity pays you $4500 (4.5%). Net, every month that year, the insurer deducts $501.67 from your account, paying $375.00 to you and $126.67 to itself. These values may change, depending on the performance of the mutual fund. It's possible for the annuity fees to increase while the payments to you remain flat. On the other hand, a legal rider to the annuity contract guarantees that payments to you will never decrease, and stipulates a formula by which they will increase if the underlying investments rise above their value at the time of purchase.
• Self-CPI. This option is not an annuity. It's a direct investment in the same mutual fund that underlies the Rider option. But the fees are lower, under $16 monthly, because none of the annuity fees apply, and the fund is held in an IRA account with no employer-related fees. It's a self-managed plan, where the investor uses the "collared inflation" method described here and implemented in our retirement income calculator. This method starts with an initial payment of $4020 (4.02%) because of the age of the hypothetical couple. It increases the payment each year by the smaller of (a) 6.7% or (b) last year's change in the Consumer Price Index. The limit of 6.7% is a "collar" which, historically, has been necessary to protect against depleting the fund in the worst case of 40+ years in retirement with inflation initially at extreme levels.

I was able to obtain market data since 1972 for the domestic stock, international stock, and domestic bond indices underlying the Rider and Self-CPI options (but not for the international bond index, which was added to the mutual fund only very recently). This data was used to simulate what would have happened if an investor had begun each of the options above under three scenarios:

• From January 1972 to December 2014, a 43-year retirement with wide variation in markets and inflation.
• A 21-year retirement starting in 1973, when stocks crashed then rose, and inflation started very high.
• A 21-year retirement starting in 1994, when stocks and bonds both rose and fell, but inflation was low.

The simulations are necessarily conjectures. The annuities being simulated were not available to be purchased during these time-periods, and had they been, their prices, interest rates, and contractual terms might have been different from what is sold today. Thus, the analyses reported below must be viewed as suppositions about what might happen if today's annuity products were to experience future markets for stocks, bonds, and interest rates resembling markets of the past.

First, the good news. All four options provided payments every year for 43 years. Even better, the Self-CPI option had a residual value of $209,650, adjusted for inflation, in 2014. Yes, you read that right. With the money left in 2014, the investor's heirs would have had twice the buying power of the couple's original $100,00 investment in 1972. The annuities, as annuities, had no residual value. Instead, any profits went to the insurers.

However, because 43 years is a long time, because inflation was high in the 1970's, and because the period included multiple large swings in the values of stocks and bonds, the four options paid out very different amounts from year to year. The chart below shows how they differed, over time. It's important to note that in the chart, all values are inflation-adjusted to show constant buying power, pegged to January 1972.

Viewed in terms of buying power, the SPIA-CPI option was the clear winner. When adjusting for last year's inflation, it sometimes lost a bit of buying power if current-year inflation was high. But over the long term, it guaranteed constant income, in real, inflation-adjusted dollars. 

The SPIA-3% option underestimated the high inflation of the 1970's and never caught up. Had this annuity been purchased with a 4% annual increase instead of 3%, the initial payment would have been a bit smaller, but the decline during high inflation would have been more limited. Eventually the initial buying power would have been nearly restored, as the compound rate of inflation for the entire 43-year period was 4.14%.

The Self-CPI option, because of its 6.7% cap on annual increases, fell behind inflation in the 1970's, but leveled out from 1980 onward. In effect, this method made a trade-off. It kept a large bequest as a result of cautious withdrawals.

The Rider option, when adjusted for inflation, fell short on its promise that payments would never decrease. Yes, in nominal dollars, the same amount was paid every year throughout the 1970's, but within a decade, inflation cut the buying power of those dollars in half. When huge bull markets in stocks and bonds began in 1982, the Rider option swiftly recovered, only to lose ground again after the dot-com bubble burst in 2000. Of all four options, this one had the least consistent payouts, adjusted for inflation.

The foregoing analysis comes with a big caveat. It's for a very long retirement in a unique historical period. Your experience in retirement will almost certainly be different. Consider, then, two other examples, both 21 years in length, one from January 1973 to December 1993; the other, from January 1994 to December 2014.

During these two periods, the underlying mutual fund of the Rider and Self-CPI options had compound, inflation-adjusted returns a bit higher than 5% per year. In this respect, the stock and bond markets were, overall, about average during both periods, despite some dramatic swings along the way.

At 21 years, both periods were also average in another sense. They fit the joint life-expectancy of a couple in their late 60's.

A key difference, however, is that in the first period, 1973-1993, inflation was abnormally high (6.05%), while in the second, 1994-2014, inflation was much lower (2.30%). Because of inflation, the SPIA-CPI option did the best job of maintaining payments at constant buying power in the 1973-1993 period; the other methods lost about 25%, falling close to $3000, inflation-adjusted. In the low-inflation period from 1994 to 2014, however, all the options preserved buying power, and the SPIA-3% and Rider payments actually bettered inflation. The chart below displays the average payments, after adjusting for inflation.

As shown in the next chart, only SPIA-CPI generated annual increases that kept pace with the 6% rate of inflation in the first period, while all the options matched or beat the tame 2.3% rate of inflation in the second period.

Finally, as with the 43-year analysis, the Self-CPI option was unique in preserving a bequest. Adjusted for inflation to reflect constant buying power, Self-CPI preserved principal approximately equal to the initial investment, in both 21-year periods: $90,756 at the end of 1972-1993, and $144,631 at the end of 1994-2014. The three annuities, by design, left nothing.

The examples presented here are for selected options and time periods. As such, they cannot be taken as guarantees of future performance or as definitive recommendations of certain products. Your results may differ, and will, as with any investment, entail a risk of loss. With those important cautions in mind, consider the following key insights from these examples:

• If one's goal were to guarantee constant buying power, SPIA-CPI would have been the best of the options examined above. A SPIA with a 4% or 5% annual increase might have performed comparably for periods of high inflation, but would have been more than necessary under normal levels of inflation.
• If one's goals were to preserve constant buying power and also leave a bequest, Self-CPI would have been the best of the options studied here. However, it would require active management by the investor (or by a paid adviser), which sets it apart from the annuity options.

When my father retired, he was fortunate to have inherited assets from my mother, who had died too young several years earlier, and from his own father. I remember my father saying his goal was to live on the interest and leave the principal for my three siblings and me. There was no way he could have known that the next decade would bring constant inflation and poor markets. A frugal spender who had no formal knowledge of finance or economics, he was happy, I suspect, to see the dollars in his account hold firm over the years, unaware that adjusted for inflation, they were worth much less than when his retirement began. I'm not complaining. He richly deserved every penny he spent, and then some.

Looking back on my father's experience and thinking ahead to my own retirement, I would reframe his twin goals of living on interest and preserving principal. Instead, for any retiree, I see the objectives as a triplet:

• Covering expenses. As noted earlier in this series, insured income from Social Security, possibly supplemented by a lifetime, inflation-adjusted annuity, may partially achieve this goal. The rest would come from managed investments.
• Holding emergency reserves. Unless one's retirement accounts are very large, some portion should be managed separately for unplanned expenses such as uninsured medical costs, accidental damage to property, or dependents' unforeseen needs.
• Leaving a bequest. For those lucky enough to have assets exceeding their own needs for normal expenses and emergency reserves, the remaining funds may be managed as future gifts, donations, or inheritances.

Historical data on U.S. stock and bond markets implies that one method of money-management may work best for emergency reserves. This post covers that method. For living expenses and bequests, a different method may be better, so those goals are covered separately, in the post on finance strategies.

Previously, I described a set of historical data on U.S. stock and bond markets since 1924, with which I studied the experience of hypothetical investors, all of whom retired at age 65 and lived to 95. The analysis had 62 cohorts, each starting in January of a year between 1924 and 1985, and ending 30 years later in December of a year between 1974 and 2015. For these cohorts, I considered three methods of managing retirement funds.

• Flat Percentage. Annually, a fixed percentage is withdrawn from a retirement account, while the remainder is left to grow over time. Variants of this method turn out to work best for managing emergency reserves. The method is similar to how universities and foundations typically manage their endowments.
• Required Minimum Distributions (RMD) . As dictated by the Internal Revenue Service, retirees at 70.5 years and older must withdraw a portion of their traditional IRA, 401(k), 403(b) or 457 accounts annually and pay taxes on the amount withdrawn. Each year, the mandatory portion increases, because the tax-collectors want their due. Consequently, the RMD method works poorly for emergency reserves and bequests. By design, it depletes the accounts of those who live long lives. It won't preserve a surplus for unexpected needs or posterity. Furthermore, if reserves or gifts are held in Roth or taxable accounts, as may be advantageous, then withdrawals are not obligatory, and the RMD method is irrelevant.
• Inflated 4%. This method withdraws 4% of an account's initial value at the start of retirement, then increases the withdrawn dollars each year by the same percentage as the previous year's inflation in consumer prices, or, less commonly, decreases it by the amount of deflation. It's really a variant of the flat-percentage method, but one that risks depletion of the account if inflation runs high for many years. For this reason, it's a non-starter for all except very short retirements.*

With flat-percentage as the method of choice, I ran simulated retirements for the 62 cohorts from 1924-1953 to 1985-2014, across withdrawal rates that ranged from 0% to 5% annually.

I first looked at a portfolio with 35% in U.S. stocks, 50% in 10-year U.S. treasury bonds, and 15% in 2-year U.S. treasury notes. Allocating 35% to stocks was a compromise between capturing the long-term, inflation-beating power of stocks and earning the shorter-term, stable return of bonds. In my previously reported study of inflation, a 35% allocation was a good choice for funds likely to be spent five to six years in the future, which seems reasonable as a planning target for retirement reserves. Coincidentally, the retirement income funds offered by most investment firms allocate 30% or 40% to stocks. Perhaps they should be renamed "retirement reserve funds" and relegated to the emergency-reserve portion of one's portfolio.

The chart below summarizes the simulated outcomes at the end of a 30-year retirement, for withdrawal rates ranging from 0% to 5% annually. The blue line labeled "35% Steady" shows the amount remaining after 30 years, for the middle cohort, using the 35% allocation to stocks and steady withdrawals every year. Half the cohorts did better than the blue line; half did worse. For example, at Flat0%, where nothing was ever withdrawn, the middle cohort's reserve fund had nearly tripled in buying power after 30 years. Even for Flat3%, where each year the retiree spent 3% of the reserves, the middle cohort kept 100% of its original buying power. Nice!

For comparison, I ran simulations for two additional portfolios as depicted in the chart. One, called "20% Steady" and shown by the red line, had a more conservative allocation: 20% stocks, 60% 10-year bonds, and 20% 2-year bonds. Because of the lower allocation to stocks, the returns tended to be a bit lower. Even so, after 30 years of withdrawing 3% annually, the middle cohort had virtually all its original buying power.

The final portfolio, shown by the green line labeled "35% Cautious," was the best of all. It had exactly the same allocations to stocks and bonds as the 35% Steady portfolio, but the method of withdrawal was modified. If, in the previous year, the portfolio had fallen in value, then no withdrawal was taken. However, if the previous year had positive returns, then 1% to 5% was withdrawn, as depicted in the chart. This method simplifies more elaborate strategies that many endowments use to moderate their withdrawals depending on the results of prior years. It's also what your instincts might guide you to do. After a down year, you might find yourself taking no discretionary withdrawals, while waiting for your funds to recover. That's exactly how the "35% Cautious" simulation worked, with favorable results. 

Because of normal, non-discretionary expenses, you might not be able to delay withdrawals from the rest of your retirement assets after a bad year. But non-emergency withdrawals from your reserve fund are truly discretionary. They allow you to redirect surplus funds to a vacation, to charitable donations, or to your fund for future bequests. When markets are falling, you can skip them.

If an emergency requires you to spend your reserves, it matters little what they might hypothetically earn after 30 years. You need them now. What matters, from this perspective, is the least amount you can expect to be available at any point during your retirement, not the cumulative total at the end. Accordingly, my simulations calculated the low-point for each payout method, over all 62 portfolios and all 30-year periods. For a given method, that's the lowest of 62 times 30 or 1860 outcomes. It's truly a worst-case metric, one that's lower than the other 99.95% of the method's historical results. The next chart shows this metric for each simulation.

As one example, for the 35% Steady portfolio and 2% withdrawals every year, the most dismal cohort sank to about 65% of its original buying power at one point during its 30-years of retirement. One might think that a more conservative portfolio, with less allocated to stocks, would be less volatile and thus suffer less depletion. Not so! Comparing the red and blue lines in the chart, it's clear that the more conservative 20% portfolio actually sank to lower lows than the 35% portfolio. How could this be? The reason, in brief, is that during periods of high inflation, the interest rate on bonds has often been less than the current inflation rate. A heavier allocation to bonds, if it lasts long enough during such times, will reduce inflation-adjusted returns.

The best strategy for limiting losses, across all the simulations, turned out to be the same as the one that was best for promoting gains. It was the 35% Cautious method.

This analysis has several implications for retirees.

• The retirement income funds offered by many investment firms, with about 30% to 40% allocated to stocks, may be a good match for funds you set aside as emergency reserves during retirement. This does not mean you should put all your assets in such funds, just the portion necessary for emergencies.
• If the future is like the past, then in most years you may be able to spend a modest percentage of your reserve fund, without losing any of its purchasing power, long-term. About 1% to 3% may be prudent.
• Your instinctive tendency to scale back spending after a bad year may be wise, at least for discretionary withdrawals from your reserve fund.

To learn more about reserve funds for retirees, read this related article.

* Endowments sometimes use cost-increases or inflation as part of their strategy for determining withdrawals. However, to curtail the risk of depletion, they add "collars" that prevent the withdrawn amount from growing faster than a certain rate compared to previous years. Should you be inclined to try such methods, you can find a very simple, very effective version in the post on finance strategies, or more elaborate versions here for Yale University and here for three other institutions.

Although a mixture of bonds, stocks, and guaranteed benefits may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, or type of insurance.

Do you see your Social Security benefits as a retirement account? Your view, perhaps, is that you made deposits into a personal account with payroll taxes, and, when the time comes, you will withdraw from that account. Actually, Social Security was devised not as a government-sponsored retirement account, but as a form of insurance for retirees, the disabled and their children, and widows and widowers. Payroll taxes are premiums that are paid into a pooled fund, and payments to retirees and other qualified individuals are benefits to insure them against lost income. 

Viewed as insurance, Social Security benefits should be postponed to the latest possible age, because doing so maximizes the amount of the benefit. By waiting longer to collect your benefit, you get more insurance against loss of income later in life. You might need it if you live longer than expected or have large unplanned expenses. One excellent source of information is the website, Maximize My Social Security. For a modest fee, it provides a sophisticated online calculator to compute your best option for collecting benefits.

As detailed in other posts in this series, it is difficult to use stock and bond investments to construct a retirement portfolio that will last a lifetime and reliably protect against inflation. Social Security benefits address this difficulty because they are both adjusted for inflation and paid until you depart. There's a flip-side, of course. You can't bequeath your Social Security benefits to an heir (although a spouse, former spouse, or child may be entitled to benefits of their own, because of their relationship to you). Your stock and bond investments, however, can be bequeathed to a charity or a person, if any assets remain in your estate. Because of their complimentary nature, you need both Social Security and some investments. The following list spells out the reasons, based on the payout risks likely to be of concern to a retiree:

Inflation: Will it erodes your income?

• Social Security: Guaranteed protection.
• Investments: Some protection, depending on your investment strategy, but no guarantee. Read this post for details.

Payout Volatility: Can you rely on sufficient income every year?

• Social Security: Guaranteed delivery of the same inflation-adjusted amount, every month.
• Investments: Likelihood of higher payouts some years, lower ones other years.

Longevity: Will your income sources last as long as you do?

• Social Security: Guaranteed to last your lifetime.
• Investments: May last your lifetime if you adopt a good strategy, but failure is possible.

Emergency: What if you are struck by a costly event or illness?

• Social Security: No help here. Your benefits won't increase if you suddenly need more.
• Investments: If you are wise with your strategy, you can set aside some retirement savings as a reserve or contingency fund.

Bequest: Will you be able to leave an inheritance to your heirs or charity?

• Social Security: No help here. You have guaranteed benefits to you, not to your heirs. There's no account balance that would go to your estate.
• Investments: Again, it depends on your strategy. It's possible, as other posts in this series explain, to follow a plan that has a high probability of leaving something for your estate, provided you avoid emergency payouts.

If you have both Social Security benefits and retirement investments, do you also need an annuity? For many retirees, an annuity of any kind may add little value. 

To see why, consider a typical retiree. Her actual Social Security benefits might cover 40% or more of her pre-retirement income (see, for example, a classic study by Munnell and Soto). This figure would rise if she maximized her Social Security benefits, because the actual practice, as noted in the reported studies, is that most retirees minimize their annual benefits by taking them too soon. As it happens, 46% is about how much of a typical household income is paid for housing and food expenses, according to the most recent survey by the U.S. Department of Labor. Your circumstances may differ. Still, to a good approximation, Social Security benefits may suffice to pay for your most critical expenses.

Thus, your income from investments, although it may vary from year to year, may only need to cover about 60% of your budget. If your investment income were to fall by, say, 30% in a given year, that's really 30% of 60%, or 18% of your total income. The key question is whether your budget can sustain a drop of 18% or so. If you have a reserve fund or can reduce some optional expenses or have ample investments, the answer may be yes. If not, you may want to consider annuitizing some (not all) of your investments, thereby raising your guaranteed income to a higher percentage than the 40% or so that Social Security might cover. 

Should you chose to buy an annuity, it would be sensible to get one that resembles Social Security benefits. As explained in a related article, the best annuity is fixed (not a variable annuity); it pays for your lifetime (not for a limited period); and it's inflation-adjusted.

While your individual circumstances must guide your decision, you might, as a rule of thumb, consider your options very carefully before locking up more than two-thirds of your budget in the total of Social Security plus guaranteed annuities. Certainly, if your retirement investments are more than adequate to cover your income needs beyond what Social Security insures, then converting those investments to annuities would have little value. Other posts in this series provide some guidance on making such decisions.

Disclaimer​: Although a mixture of bonds, stocks, and guaranteed benefits may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, or type of insurance.

The core ideas for a retail strategy are to use an all-in-one fund from your investment firm, and to withdraw from the fund by a simple method that requires the bare minimum of calculations.

Most investment firms offer an all-in-one fund intended for retirement income. It is typically where a target-date fund will land as it glides to your retirement date. These funds tend to be conservative, with 30% or 40% invested in stocks and the rest in various bonds. For a lengthy period of withdrawals, such as the 30-to-40 years that many retirees may experience, retirement-income funds may be too conservative. If you use our retirement calculator, for example, you will get recommendations for a higher allocation to stocks, given a spending period of, say, 30 years, starting in the current year. To cover a range of options, I ran a study with two simulated all-in-one portfolios:*

• 35% U.S. stocks (S&P 500), 50% 10-Year U.S. Treasury Bonds, 15% 2-Year U.S. Treasury Notes
• 65% U.S. stocks (S&P 500), 20% 10-Year U.S. Treasury Bonds, 15% 2-Year U.S. Treasury Notes

With funds available today, you could create similar portfolios with our Best-Invest calculator or our article on Basic Portfolios.

To take withdrawals from the simulated all-in-one portfolios, I studied three tractable methods:

• Flat 5%. In December, an amount corresponding to 5% of the portfolio's value was calculated. That amount was then withdrawn in January, to be deposited in a bank savings account and spent over the next 12 months.
• 4%-or-RMD. Instead of a flat 5%, the amount withdrawn was the larger of (a) 4% of the portfolio's December value, or (b) the Required Minimum Distribution (RMD) for a traditional IRA, 401(k), or other retirement account, as defined by the Internal Revenue Service. Investment firms often provide RMD calculators. Before age 70, RMD is not defined for a retiree; after age 72, it exceeds 4% and increases each year.
• Inflated 4%. This method is well-known and much-debated. In the first January, 4% of the portfolio's December value is withdrawn and saved to cover current-year expenses. The next year (and every year thereafter), the annual dollar amount of the withdrawal is increased by the previous 12-month percentage increase of the Consumer Price Index (in the same manner done for inflation-indexed Social Security benefits). In my study, if the previous 12-month period experienced deflation, the withdrawal was decreased correspondingly, to keep the payout aligned with consumer prices. This did happen occasionally in the historical data.

For the two portfolios and three methods of withdrawal, I generated results for every 30-year period from 1924-1953 through 1985-2014. That's a total of 2 X 3 X 61 = 366 simulated retirements. For the RMD method, I set the retiree's age at 65 in the first year of the period. For the other methods, age didn't matter.

To understand the advantages and disadvantages of each method, consider the payout risks likely to be of concern to retirees:

1. Inflation. Each annual withdrawal was adjusted for inflation, pegged to the purchasing power of dollars in the first year. As one example, for the 30-year period 1938-1967, which included a stiff round of inflation in the 1940's, here's how the three methods fared, using the 35% portfolio:

• Flat 5% was the worst of the three for 1938 retirees. Over the 30 annual payouts, the median (middle) withdrawal had a value of $63 compared to $100 in the initial year. Had you been able to buy 10 meals at $10 apiece in the first year, then over the rest of the period you typically could afford to buy only 6 meals. Some years, the number was even lower; others, a bit higher, but never more than $106.
• 4%-or-RMD afforded good protection against inflation for 1938 retirees, although with some variation year-to-year. The median (middle) value was $101. In the worst year, it was $70 (sorry, only 7 meals); in the best, $135 (splurge on three more veggie burgers or whatnot!).
• Inflated 4% provided exactly the rock-solid consistency it is designed to offer. Every year, the purchasing power remained steady at $100.

What about periods that started in other years, not just 1938? The charts above and below show the median (middle) real (inflation-adjusted) buying power, across all the time periods studied. The first chart is for the 35% portfolio; the second one, 65%. The message of the charts is that for consistency in matching inflation, the Inflated 4% method is best. It always provided a $100 payout, every year, in every time-period, for both the 35% portfolio and the 65% portfolio. However, on average, the 4%-or-RMD method, although quite variable, was even better. The middle (median) value overall for 4%-or-RMD was $114 in the 35% portfolio, and $141 in the 65% portfolio. Finally, the Flat 5% method was fine overall in the 65% portfolio, with a median of $104, but not in the 35% portfolio, where the median was $78.

Perhaps the main implication is a warning. To protect against inflation, don't use the combination of a conservative portfolio and a flat-percentage rate of withdrawal.

2. Payout Volatility. If a method of withdrawal generates consistent payouts over the years, budgeting is easy. If not, it may be hard to plan your spending. One way to gauge this risk is to look at the spread from the highest to the lowest payout, over a given 30-year period. As a baseline, I used a $100 a payout in year one, and for direct comparison, I pegged all values to year-one dollars. The results were as intimated above. Payout volatility, as measured by the average gap between the highest and lowest payouts in a 30-year period, was ...

• Lowest, literally zero, for the Inflated 4% method.
  
• Middle, and rather high at $71, for the Flat 5% method.
• Worst, and very high at $145, for the 4%-or-RMD method. Note, however, that much of this volatility was on the upside. On average, over all 30 periods, the minimum payout was $84 and the maximum was $229.

Conclusion: For consistent payouts, the Inflated 4% method is much superior.

3. Longevity. Will you outlive your portfolio? Or will it pay its last dollar before you take your last breath? In the study reported here, this risk can be judged by looking at two indicators:

• Did the payout ever fall to zero, within the 30-year period?
• After 30 years, what percent of the portfolio remained unspent? For this question, I adjusted the final portfolio value for inflation, to express it in constant, first-year dollars.

The answers are in the charts above (for the 35% portfolio) and below (for 65%).  Just when you thought the Inflated 4% method was looking good, here comes its ugly side. In the chart above, for 1937 retirees, this method depleted a 35% portfolio after 27 years. It nearly did the same for 1939 and 1940 retirees in the 35% portfolio, and twice again in the late 1960's for the 65% portfolio. Among the three methods, it was by far the most erratic. In comparison, the 4%-or-RMD method did the best job of spending down the portfolio consistently for 30 years and retaining a modest cushion for a longer life-span, while never coming close to depletion. As shown in the two charts, it held a value after 30 years that was between 40% and 100% of the original portfolio.

Bottom line: 4%-or-RMD is best for longevity, neither leaving too much unspent nor falling to zero.

4. Emergency. Which of the methods and portfolios provides the best backstop for unplanned expenses, such as a medical emergency or loss of expected income from a spouse or partner? The best metric for this risk is the minimum value to which a portfolio falls at any point in the 30-year period. The higher the minimum, the greater is the cushion for emergencies. By this criterion, the Inflated 4% method is ruled out altogether, as it allowed the portfolio to fall to zero (or very close) in several of the time-periods. The best method was Flat 5%, where the overall minimum was 40%. The 4%-or-RMD method was not far behind, at 32%. 

For any given method, there was not much difference between the minimums for the 35% and 65% portfolios.

The conclusion in this case is another warning: To guard against emergency expenses, don't use the Inflated 4% method.

5. Bequest. If your goal is to leave an inheritance for children or charities, what method best limits the risk of falling short? To quantify the risk, two measurements are needed. One is the minimum portfolio value; if it goes to zero, there's no bequest. This rules out the Inflated 4% method. The other is the average ending value; it should be as high as possible. By this measure, Flat 5% scored higher (89%) than 4%-or-RMD (64%).

Bottom line: To leave a bequest, don't use the inflated 4% method, and view Flat 5% and 4%-or-RMD as you first and second choices, in that order.

Among the methods examined in this study, using all-in-one funds, none of the alternatives was best on all the risks. Each had some weaknesses. The Inflated 4% method was unique, however, in having some risks one might consider to be fatal. Its poor showing on longevity and emergency preparedness would make it ill-advised for many investors and retirees. Happily, as explained in the post on finance strategies, a modified version of the Inflated 4% method can overcome its limitations. For any of the methods, the key may be to adopt a combined strategy, managing some portion of assets with one method and the remainder with a different method. For example, one might establish one account for emergency preparedness and bequests, to be managed in one way, and handle retirement withdrawals in a separate account, by a different method. To learn more, read the related article on Retirement Income, or try our Safe-Payout calculator, or use the links at the beginning of this post.

Disclaimer​: Historical data cannot guarantee future results; your results may differ. Although a mixture of bonds and stocks may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, or type of insurance.

* Monthly data for stocks and 10-Year treasures came from Shiller. For 2-year treasuries, I did a regression analysis on 10-year treasuries, 2-year treasuries, and 3-month T-bills for the years 1976 to 2014, using data from the St. Louis Federal Reserve (FRED) database. The analysis generated an equation that predicted 2-year treasury interest rates as a function of 10-year treasury rates and 3-month T-bill rates. The regression model explained 99% of the variance in 2-year treasure rates for 1976-2014. I then applied that model retrospectively to historical 10-year treasury and T-bill rates, going back to 1920. A similar model used 10-year treasury rates alone to estimate what 2-year rates would have been from 1871 to 1919. This model, while less precise, nonetheless explained over 90% of the variance for 1976-2014

If you read the legal prospectus for one of your investments, you'll find an obligatory listing of risks. It is likely to include items such as stock-market risk, currency risk, interest-rate risk, and many more. In truth, these alleged risks are really potential reasons that your investment may fluctuate in value, maybe to your detriment (or maybe not), maybe by a large amount (or maybe not by much). These are not really the risks you care about.

What truly matters are the following five risks:

• Inflation. Will the prices you pay for housing, food, transportation, and health care grow so fast that your quality of life erodes? Over time, will you become unable to afford your basic needs? Fortunately, inflation is extremely low right now, but no one knows where it will be in the future. Had you been in the unlucky cohorts that retired in the late 1930's or 1960's, the extended inflation of the following decades would have significantly impaired your standard of living.
• Payout Volatility. No, not the volatility of the markets, the bubbles and crashes that are reported in the news. The volatility of genuine concern is whether the amount of your payout has enough stability for you to sensibly plan your budget. It matters not a whit that the stock market crashes, if your payout strategy guarantees a consistent spendable income. On the other hand, it may matter a lot if your payout plan is overly sensitive to market gyrations, causing your income to change significantly from one year to the next.
• Longevity. You don't want to outlive your income. If you expect to live to be 85 or 90, but medical advances enable you to live well past 100, your investments may run dry. On the other hand, if you pass on much sooner than expected, you may leave money unspent that, had you known better, you would have allocated to more time on sunny beaches or in museums or with family members dispersed across the country. Ideally, if you knew exactly how much life remained for you to enjoy, you would spend accordingly. But none of us know that, so we need a payout strategy that intelligently copes with the uncertainty.
• Emergency. Even the best-laid plan can be overpowered by an unforeseen emergency. It may be a severe economic downturn, like the one in 2008, which has long-lasting negative consequences for your ability to earn income. Perhaps it's high, uninsured medical expenses for you or a dependent. Maybe it's a divorce that came from nowhere and sent your wealth to a place of no return. The point is that a payout plan will normally have a cushion of some sort, to soften the pains of the unexpected.
• Bequest. Do you have an idea how much of your wealth will remain after you are gone, and who will get it? Maybe you want to leave something to your favorite charity, or to your children. Or, maybe you want to spend it all and leave a bequest of exactly zero. The risk is that the bequest you eventually leave may differ radically from the one you intend. For many, this risk may carry less weight than the risks of inflation, payout volatility, longevity, and emergency readiness. However, even if it carries less weight, it shouldn't be ignored.

Consciously or by default, you will adopt a strategy to manage your payouts. You might take the advice of a financial planner, or use a software program for guidance, or passively accept the dividends that your investments deliver. Whether you have given it lots of thought or none at all, you will have a strategy. Here's the rub. It may or may not be one that's optimal for your objectives.

As this series unfolds, we'll look at several strategies. Generally, each strategy has both strengths and weaknesses. It will manage some risks better than others. One strategy may completely control certain risks and totally ignore others. Another strategy may address all the risks to some degree, but require extra diligence and effort from you. None of them is without at least some caveats.

Therefore, before you study any of the strategies, think about the risks that matter most to you. If you are 90, wealthy, and in declining health, perhaps longevity risk is less important than ensuring a bequest. If you are 60, working at a job you like, and behind schedule in saving for retirement, your top concerns might be inflation, longevity, and perhaps emergency preparedness. Decide what risks are foremost in your personal priorities, and read about the strategies with your priorities firmly in mind.

You may find one strategy that perfectly meets your needs. More likely, a combination that allocates your investments to two or three strategies may prove best.

Each post in the series examined one of the following strategies:

• The retail strategy. In this case, by default, a retail investor allows a target-date mutual fund to devolve into a retirement income fund, typically with 30% to 40% invested in stocks, and the rest in bonds. Income may be taken from this fund in various ways, perhaps using Required Minimum Distributions.
• The insurance strategy. Social security benefits and annuities from an insurance company are examples of this method, which is very strong on some risks and very weak on others.
• The endowment strategy. A payout fund from Vanguard is an excellent example here. The goal is to manage payouts the way an endowment fund for a foundation or university would manage their assets. One version of this strategy works nicely for a reserve fund.
• The finance strategy. A product from Betterment is an automated implementation of this approach, and the Bogleheads forum has an approximate version done as a downloadable spreadsheet. At the core of this approach are concepts from what economists call the time-value of money, coupled with attention to life-expectancy and portfolio composition. Happily, really simple, effective variants of this method are available in our safe-payout calculator.
• The smooth consumption strategy. With sophisticated models from economic research, coupled with online databases and algorithms, this strategy aims to manage all the risks, while generating an affordable, life-long spending plan. ESPlanner has the necessary software, which is not for the faint of heart. But a basic version is free, easy to learn, and offers great insights for your retirement plan.

This post is the fifth and last in a series about investing to protect against changes, up or down, in consumer prices. Previous posts argued that historically:

• Stocks have offered the best protection against inflation over the very long term (18+ years), 
• In the short term (0-5 years), investing exclusively in one type of bond fund may be ill-advised. Instead, a mix of short-term corporate and treasury bonds plus short-term TIPS may be prudent.
• Over a holding periods from 1 to 20 years, intermediate-term Treasuries are paradoxical. They offer better average returns but a greater risk of lost purchasing power, compared to short-term Treasuries.
  
• Adding a small allocation to stocks may create a portfolio well suited for 1-year to 5-year investments, having compound returns like intermediate-term bonds and price-protection like very short-term bonds.

In this post, I investigate how increasing your portfolio's allocation to stocks may generate sensible strategies for longer-term investing of 5 to 20 years.

The portfolios in this analysis are based on the data described in a previous post. There I considered a mix of 10% U.S. stocks, 20% intermediate-term Treasuries, and 70% short-term TIPs and bonds, which historically has had compound returns like intermediate-term Treasuries and price-protection like diversified short-term bonds. As an investment strategy, this mix looked attractive for short time-horizons, perhaps 1-5 years. As a point of comparison for longer periods, I flipped the percentages of stocks and short-term bonds, creating this portfolio:

• 70% U.S. stocks
• 20% 10-year Treasuries
• 10% 2-year Treasuries

The chart below shows how, from 1920 to 2014, this portfolio compared to one invested entirely in stocks and to the portfolios reported earlier in this series. All the portfolios were rebalanced quarterly, if more than 3% out-of-balance, using methods explained here.

If you had invested in 1920, totally ignored all the exciting and disturbing events that transpired for the next 94 years, and cashed out in mid-2014, putting all your money on stocks would have been the best strategy. If, on the other hand, you were not able to anesthetize yourself against churning markets and had less than 94 years of patience, would the portfolio with 70% in stocks have been better? In the chart above, the answer is not obvious. Yes, there was somewhat less churn, but it was still a bumpy ride.

Suppose, instead, that your time-horizon is 17 years. Perhaps you are investing a lump-sum toward the future college education of a newly born grandchild. Or you are investing this year's 401(k) contribution, with a plan to purchase a life-time fixed annuity when you retire 17 years from now. (As a retirement strategy, this may be a sensible plan in some limited cases, if your overall savings are low.)

If you had invested for 17 years starting in 1928, your results would have been as shown in the next chart, which has the same set of portfolios. This particular period had deflation in the early 1930's, inflation during the 1940's, and a severe economic downturn during the Great Depression. Voila! In this instance, the portfolio that had 70% invested in stocks was the best of the lot.

Of course, this one example proves nothing. To see why, consider a second example, the 17-year period starting in 1966. Here a very sharp recession occurred, but no deflation. Instead, inflation was high and persistent. In this case, the bond-heavy portfolios all did better than the stock-heavy portfolios. However, the stock-portfolios kept pace with inflation overall, and a 70% allocation to stocks did a bit better than 100% in stocks.

The flaws in the analysis above are twofold. We should ...

• Consider all time periods, not just the two that started in 1928 and 1966.
• Examine stock-allocations that increase from around 10% for short holding periods to 70% or more for long ones.

Using the same method of analysis reported earlier in this series, I examined all holding periods of 1, 3, 6, 9, 12, 15, 18, and 21 years duration, since 1920. I did so for the portfolios shown above, with a new twist. Instead of a portfolio always invested 70% in stocks, I created one that grew the stock-percentage as the holding-time lengthened:

• For a 1-year period, only 10% went to stocks. 
• For each additional year, the stock-percentage grew by 5%, until it reached 80% at 15 years.
  
• After 15 years, the stock-percentage remained at 80%.
• The allocation to short-term bonds decreased by the same amount that the stock-percentage grew. Thus it fell from 70% for a 1-year holding to 0% for 15 years.
• The allocation to intermediate-term bonds remained at 20% throughout.

As shown in the next chart, this new portfolio rarely lost purchasing power. By this metric, the portfolio with a growing percentage of stocks did better than both 100% in stocks and 100% in intermediate Treasuries. It also did nearly as well as the portfolios that were stacked with short-term bonds.

Furthermore, when losses did occur for the new portfolio (under 10% of the time in holding periods from 6 to 15 years long), the amount lost tended to be small. As the next chart shows, the losses amounted to about a half of one percent in purchasing power, on average.

Importantly, the compound return of the portfolio with increasing stock-allocations was strong even after adjusting for inflation. The final chart shows how the inflation-adjusted return grew as the stock-allocation increased.

Considering all the posts in this series, historical data implies that an investor can get price-protection (against losses to inflation and deflation) and also get good compound returns, by crafting a portfolio in which:

• The allocation to stocks grows with the length of the holding period. This provides inflation-protection long-term.
  
• A modest amount is allocated to intermediate Treasuries for all holding periods. This guards against deflation and recessions.
• The remainder is allocated to a diversified mix of short-term TIPs and bonds. This assures some stability of returns, particularly for near-term spending.
• The portfolio is rebalanced approximately quarterly, if it is more than 3% out of balance.

One might use slightly different percentages than illustrated above, and still get good results. Furthermore, with the funds and ETFs available now, it would make sense to invest the stock portion in both U.S. and international stocks, and to diversify the short-term portion across Treasuries, 0-5 year TIPS, and corporate bonds.

Historical data cannot guarantee future results. Although a mixture of bonds and stocks may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, or type of insurance.

This post is the fourth in a series about investing to protect against changes, up or down, in consumer prices. Previous posts argued that historically:

• Stocks have offered the best protection against inflation over the very long term (18+ years), 
• In the short term (0-5 years), investing exclusively in one type of bond fund may be ill-advised. Instead, a mix of short-term corporate and treasury bonds plus short-term TIPS may be prudent.
• Over any holding period, as short as 1 year or as long as 20, intermediate-term Treasuries are paradoxical. They offer better average returns but a greater risk of lost purchasing power, compared to short-term Treasuries.
  

In this post and another one to be published soon, I add some stocks to the mix, to see whether doing so might resolve the paradoxical properties of bond-only strategies and provide a sensible strategy for intermediate-term investing of 5 to 20 years.

The core question for today's post is whether a portfolio that contains a small allocation to stocks plus a good mix of bonds can meet two objectives:

1. The rate of return is at least as good as the historical rate for 10-year U.S. Treasuries. That's about 2.3% to 2.6% above the rate of inflation.
2. The risk of lost buying power is similar to 2-year U.S. Treasuries. It's consistently very, very low, even for holding periods as short as one year,

One reason to expect that stock investments would help a portfolio achieve these objectives is the experience of 2011-2014 in U.S. markets. During this period, inflation was very low, and short-term interest rates were even lower. Consequently, Treasury bonds and TIPS actually fell in value when adjusted for inflation, while stocks (and to a lesser extent, corporate bonds) rose. Another reason is that during a period of protracted inflation such as the 1940's, stock-prices might rise enough to compensate for losses in bonds.

As additional background on how a diversified portfolio can help investors manage the contradictory risks of inflation, deflation, and interest-rate polices, I recommend a recent article from Vanguard's chief economist and the manager of their TIPS funds. It's well worth reading.

To cover a long historical record that included inflation, deflation, and economic growth, stagnation, and recession, I analyzed data for the period from January 1920 through June 2014. TIPS did not exist for most of this time, nor did I have adequate data on corporate bonds or non-U.S. investments for the entire period. The analysis was therefore limited to three classes of investments:

• U.S. large-company stocks, as represented by the S&P 500 with dividends reinvested (from Shiller).
• U.S. 10-year Treasury bonds, with interest reinvested (also from Shiller).
• U.S. 2-year Treasury bonds, as reported by the U.S. Treasury Department since 1976, and extrapolated backwards to 1920 by a statistical model that I developed which had virtually perfect accuracy (explaining 99% of the variance). The model regressed interest rates on 2-year treasuries against the interest rates of 10-year treasuries and 3-month T-bills.

For all three class of investments, I took two additional steps:

• The monthly rate of return was adjusted for that month's change in the Consumer Price Index.
• The portfolio was rebalanced quarterly, if and only if the average deviation from target allocations was 3% or more. This strategy was used because of findings I've previously reported for various rebalancing strategies. (See overall recommendations here and specifics for the quarterly strategy here.)

After looking at numerous combinations, I settled on the following as an excellent portfolio, within the constraints of the data available for the analysis:

• 10% U.S. stocks
• 20% 10-year Treasuries
• 70% 2-year Treasuries

A portfolio like this may be advantageous for investments that are possibly to be spent soon, such as an emergency or reserve fund, or a safety-net for unplanned health care costs, or the portion of a retirement portfolio set aside to cover living expenses for the next 1-5 years. In such cases, the goal is to achieve a modest return above inflation, if possible, while minimizing any risk of lost purchasing power. 

Below is a chart that shows historical results since 1920 for the 10-20-70 portfolio, and for portfolios invested entirely in 10-year or 2-year Treasuries.

The charts shows that the mixed portfolio, over the long term, had virtually the same compound rate of return as 10-year Treasuries, handily surpassing 2-year Treasuries and thereby satisfying objective #1. In addition, the chart suggests that the variation from year-to-year was lower for the mixed portfolio than for 10-year Treasuries, which would satisfy objective #2. This was particularly true from 1930 to 1950, when 10-year Treasuries rose strongly during the initial years of the Great Depression, then rapidly lost buying power because of the inflation that accompanied World War II.

For a closer look at objective #2, consider the next chart. It shows the percent of periods when a portfolio lost ground to inflation, for periods ranging in length from 1 year to 21 years. This chart confirms that for the mixed portfolio, the risk of lost buying power was always less than for 10-year Treasuries, and was nearly as low as 2-year Treasuries.

Furthermore, as the next chart shows, when losses did occur, they were very small for the mixed portfolio. In the rare occasions when losses occurred, the cumulative loss in buying power, over any holding period, was virtually zero for both 2-year Treasuries and the mixed portfolio. In contrast, for 10-year Treasuries, during the more frequent periods when losses occurred, the cumulative loss was, on average, about 1% to 3% in buying power.

Historically, for U.S. investments since 1920, a portfolio invested 10% in stocks, 20% in 10-year Treasuries, and 70% in 2-year Treasuries would have satisfied the twin objectives of having returns similar to intermediate bonds while providing robust protection against changes, up or down, in consumer prices. It may be a good portfolio for near-term objectives such as a reserve fund. However, the 10-20-70 mix would not be prudent for inflation-protection in long-term investments such as retirement plans or college savings more than 5-10 years in the future. That will be the subject of the next post in this series.

Note, too, that if one were to implement this portfolio with vehicles available today, it would make sense to have the stock portion invested in a fund that includes both U.S. and international stocks, and to have the 70% in short-term bonds diversified across Treasuries, TIPS, and corporate bonds. And the 10-20-70 percentages are not absolute. Modifying them by 5% or 10% would have generated similar results, historically. If your investment firms offers an all-in-one fund close to the 10-20-70 targets, and the fees are under 0.4%, I would personally find the all-in-one fund more attractive than having to manage a set of funds or ETFs exactly matching the targets.

Historical data cannot guarantee future results. Although a mixture of bonds and stocks may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment or security.

If you have a 401(k) or 403(b) account from a former employer, should you move it somewhere else? After reviewing the factors outlined here, you will be able to make an informed decision. Should you decide to move the account, you would be wise to consider two options:

• Transfer to an IRA account at a good firm. See our review of the best firms.
• Transfer to the retirement plan of your current employer. If the plan has low fees or it meets other criteria explained below, this may be worth considering.

Probably the most important question to ask yourself about transferring your 401(k) or 403(b) is whether it will help you manage your money. Are you paying attention to your retirement accounts? How much time are you willing to invest to keep track of them? Would it be helpful to consolidate in fewer accounts? Thinking about these questions, you may decide it would be easiest, and smartest, to have the minimum number of accounts:

• A 401(k) or 403(b) account with your current employer.
• An IRA account that aggregates all the 401(k) or 403(b) funds from previous employers. It might also include some direct contributions that you make.

But before you rush off to do that rollover, consider a few more questions.

How do the fees of your old 401(k) or 403(b) compare to the fees at the firm where you might move your investments? Finding the fees of a 401(k) or 403(b) plan can be difficult. There are step-by-step instructions here. If it turns out that an account from a former employer meets our benchmark level of 0.4% ($4 per $1000 per year), you may want to consider keeping your investments there. If not, read on.

You'll need to find out out whether you would face any termination fees. The main types are:

• Surrender charges on an annuity. If you have an annuity in your 401(k) or 403(b) plan, it may charge an extra fee for terminating the annuity contract. Read the prospectus, or talk to your vendor, or try the 403bCompare site for your vendor's fees. Normally, the only way to eliminate these charges is to wait longer.
  
• Back-end loads on a mutual fund. This type of fee is charged when you sell a fund. The fund is normally listed as "Class B" if it carries a back-end load. Verify the fee with your vendor's representative, because these fees are sometimes waived. If a back-end load applies, you cannot escape the payment. You will have to pay now, during a rollover, or later, when you retire. It may be less now than in the future, so a back-end load is actually a reason to rollover, not a deterrent.
• Frequent trading fees. If you purchased a fund within the previous 30 to 90 days, your vendor may charge a fee (maybe 2%) when you sell the fund. Check the fund prospectus or ask your vendor's representative. If fees apply, you will have to wait a few weeks until they are no longer charged.

In a traditional IRA account, you must begin taking withdrawals in the year you reach 70.5 years of age. However, in some 403(b) and 401(k) plans, you may not have to take withdrawals from your current employer's vendor until you stop working for that employer. For past employers, as for a traditional IRA, you have to take withdrawals in the year when your age hits 70.5 years. Then there's a Roth IRA, where you never face mandatory withdrawals until you die (and then your heirs have to spend it). And did you know about the special case for pre-1987 contributions to a 403(b), which don't have to be withdrawn until you are 75? Confused? Consult the IRS for details ... or focus on the following key points concerning a rollover:

• If you plan to work past age 70 and your employer won't require withdrawals, you may want to consider transferring 401(k) or 403(b) accounts from previous employers into the one for your current employer.
• If you will be working past age 70 and your current tax rate is low, you may want to consider transferring some or all of your old 401(k) or 403(b) accounts to a Roth IRA. Be careful. You will have to pay some taxes on the amount transferred, so check with your tax adviser before doing this.

Before you start, please note! Do a trustee-to-trustee transfer, not a rollover. In a rollover, you liquidate the old account, get a check, deposit it in your bank account, then send a check to your new vendor. The IRS lets you do this tax-free only once every 12 months. Do it twice in 12 months, and you'll owe taxes. Also, if the process takes too long, you may owe taxes. In a trustee-to-trustee transfer, your old vendor sends a check to your new vendor. There's no IRS limit on annual frequency and no tax liability.

Able to Pay LLC is not a tax adviser. You should consult the IRS or your tax adviser about tax consequences. None of the information here should be taken as advice or solicitation to buy a particular fund, security, product, annuity, or type of insurance. You are responsible for your investment decisions, and should read the prospectus and disclosures for a security before investing. Investments have risks; you may lose money. Please read our full disclosures and our Fiduciary Oath.

Can you contribute more to your employer's 403(b) or 401(k)? And if you can, should you? Or would it be better to sink those extra dollars into an IRA? Making the right decision can have a big impact on your eventual retirement income. If your employer's plan has high fees, you can do a lot better by putting those dollars to work in an IRA at an investment firm that has low fees. 

How much better? Suppose your employer's plan charges an extra 1% in fees each year (as many do), causing your pre-fee returns of 6% to get reduced to 5%. Over 10 years, if you contributed your dollars every year to a low-fee IRA, instead of your employer's plan, they would grow to a total that's nearly 5% bigger. And over 20 years, your dollars would grow 11% more.*

If that sounds enticing, here's how to proceed. First, you need to know your target, the number of dollars you need to save each year to meet your retirement goal. Advisers often recommend 10-15% of your pre-tax income. Or you can use our retirement calculator to get a more precise estimate. Next, subtract the all the following types of contributions that go to your 401(k) or 403(b):

• What your employer contributes, if they do.
• What your employer requires you to contribute, if you have mandatory contributions.
• The total of your contribution plus the employer's match, if the plan includes an employer-match.

Finally, at this point in the calculation, if you have not met your target, consider contributing to a Roth IRA or a tax-deductible traditional IRA, at one of the best firms. In most cases, the Roth option will be the better choice. And last, if you still haven't met your target, make some additional voluntary contributions to your employer's 401(k) or 403(b). There are some additional details you will have to consider, regarding IRS regulations, so read on, buckle up your seat-belt, and ride through the complete 10-step process. And consult your tax-adviser, to be sure you've got the details right for your situation.

None of the information here should be taken as advice or solicitation to buy a particular fund, security, product, annuity, or type of insurance. You are responsible for your investment decisions, and should read the prospectus and disclosures for a security before investing. Investments have risks; you may lose money.  Able to Pay LLC is not a tax advisor. Please consult your tax advisor, and read our full disclosures and Fiduciary Oath.

* Since you invested more each year, your savings have been growing, on average, for about 10 of the 20 years - some longer, some shorter - so the cumulative gain is about half of 1% per year, plus some compound interest.
** If you are not covered by an employer's 401(k) or 403(b) plan, but your spouse is, your spouse should be reading this, not you. Be aware that for you, there's a different wrinkle. You can't claim a tax-deductible contribution to an IRA if your modified AGI is over $181,000, either on a joint return or an individual return.