If possible, spend less when markets are down

Q: One of your articles on required minimum distributions (RMDs) used an example of $100,000 with a 6 percent annual gain. Our concern is, suppose the market drops by 15 percent after you've taken an RMD. Your principal could be reduced below $80,000. That's a big hit.

What funds can one put in an IRA to protect against the losses of such a reduction? It took the last five years to get back to where we were. And because of age considerations, we would like to be better prepared for the next event. - J.H., by email

A: Sadly, there is nothing to protect us from bear markets. That's why most people try to reduce the risk level of their investments a few years before they retire. It's also good to remember that having to do a required minimum distribution may require you to pay taxes - but it doesn't require spending every dime of the money withdrawn. In a severe market drop, some of the money can be invested in a taxable account, reducing the impact of the RMD.

Many of the researchers who have explored the safe withdrawal rate problem have come up with spending rules that are helpful. They suggest reducing spending in a down market, expanding in an up market.

Q: I am a federal law enforcement officer employee, about four years from retirement eligibility. I invested in the Thrift Savings Plan for about 18 years. I was aggressive in the early years - 100 percent stocks. Over the last eight years I have I dialed it back slowly (80/20, 70/30) and am now at 60/40.

The current balance is $515,000, and I'm putting in the max plus catch-ups, for a total (with match) of $31,000 a year. My goal is a modest growth portfolio (6 to 7 percent return) from now until I die. My current asset allocation is 35 percent C Fund (S&P 500 index), 15 percent S Fund (Wilshire 4500 index), 10 percent I Fund (EAFE index) and 40 percent G Fund (government Treasuries).

Is this a good stock allocation? I've tried to create a total stock market index, but really have no idea if the 35/15 C/S funds split is effectively doing this. Also, your thoughts on a 60/40 allocation generally?

I plan to retire at 54; I need to cover 35 years of retirement. I know the Trinity/Bengen studies used a 60/40 mix for a 30-year period. I'm looking at 35 years, but my wife is seven years younger than me, so I sometimes debate whether it should be 75/25. Finally, I'm not in the F Fund because interest rates have nowhere to go but up, and I expect that fund to take a beating when it does. I'm happier with the 2 percent no-risk G Fund for the time being. - L.O., by email

A: The S&P 500 index stocks account for about 80 percent of the entire U.S. stock market. So if you want something close to the Total Stock Market index or Wilshire 5000 index, the correct mix for a 60/40 portfolio would be 48 percent C fund and 12 percent S fund. This excludes any international investment.

International stocks account for about half of total world market capitalization, so a market index-related 60 percent commitment to global equities would be 30 percent in the I fund, 24 percent in the C fund and 6 percent in the S fund.

Your current commitment to the S fund (small-cap stocks) may increase the long-term return of the portfolio, but it would do that at a significant increase in market risk. The volatility of small stocks, as measured by standard deviation of returns, is more than 50 percent greater than the volatility of large stocks. So your current portfolio is pretty risky for a 60/40 portfolio.

In the Trinity studies (and others since), portfolio survival appears to optimize in the range of 50 to 75 percent equities. The 60/40 mix has served many institutions well for decades. What you personally choose should depend on how much of your basic retirement spending will be covered by Social Security and your government pension.

If your core expenses are covered - as they will be for many government employees - you should feel free to move toward 75/25. Why? Because less of your standard of living will be at risk. It might also help your portfolio survive longer than the typical 30 years.

• Scott Burns is a principal of the Plano, Texas-based investment firm AssetBuilder Inc., a registered investment adviser.

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