It happens to everybody. After spending your working years accumulating money, you face a rude awakening in retirement when that growth is replaced by withdrawal. This drawdown phase might be described as the relentless cracking of the retirement nest egg.

Analyzing how asset allocation affects portfolio durability during retirement is a big issue, particularly considering the vast numbers of retirees who will hit the shores of retirement over the next 18 years. Here's the math: The leading edge of the baby boom was born in 1946. People born that year are 65 years old in 2011.

Thus, the leading-edge baby boomers are starting to retire now. The last group of baby boomers won't retire until the year 2029 (65 years after 1964, the last year of the baby boom).

The staggering detail here is this: Between now and 2029, about 76 million baby boomers will retire. That group of people is equivalent to one quarter of the current U.S. population. Suffice it to say, the financial planning community is facing a daunting task as it prepares to advise seemingly countless numbers of retirees who will be seeking guidance as they transition their investment accounts into retirement income accounts.

THE BASICS

This article examines retirement portfolio survival during the distribution phase-the period of time when clients are systematically withdrawing money in their retirement. This study covers the 41-year period from 1970-2010.

We examined three retirement portfolios in this analysis: an all-bond portfolio, a 60/40 portfolio consisting of 60% large U.S. stock and 40% U.S. bonds, and a multi-asset portfolio consisting of large-cap U.S. stocks, small-cap U.S. stocks, non-U.S. stocks, U.S. bonds, cash, real estate and commodities.

The multi-asset portfolio was equally weighted across all seven assets, meaning that each asset had a 14.3% allocation maintained by annual rebalancing. The performance of each of the assets in the multi-asset portfolio was measured by an appropriate index.

This analysis of retirement portfolio survival used a hypothetical starting balance of $500,000 (at the start of retirement). The initial withdrawal rate was 5%, producing a first-year withdrawal sum of $25,000. The annual cost of living adjustment was assumed to be 3%. Thus, in the second year the annual withdrawal was $25,750, in the third year it was $26,523 and so forth. Annual withdrawals took place at the end of each year.

It's important to remember that the size of the starting balance-in this case $500,000-is irrelevant to the analysis. It's just a starting value. The important variables that determine portfolio survival are the initial withdrawal rate and the cost of living adjustment.

The survival of each retirement portfolio was tested over 17 rolling 25-year periods. The first 25-year period was from Jan. 1, 1970, to Dec. 31, 1994. The second 25-year period was from Jan. 1, 1971 to Dec. 31, 1995. The last 25-year period was from Jan. 1, 1986 to Dec. 31, 2010.

ACCUMULATION MODE

First we analyzed the three retirement portfolios in accumulation mode. To do this, we measured the growth of $10,000 over a 41-year investment period.

During these 41 years, the average annualized return for U.S. aggregate bonds was 8.3% with a standard deviation of 6.7%. The 41-year annualized return for large-cap U.S. stock (S&P 500) was 10%, with a standard deviation of 17.9%. As these numbers show, the equity premium (the return of stock minus the return of bonds) has been relatively small during the past four decades.

The standard-and outdated-approach to building a blended asset portfolio often consists of combining 60% stocks and 40% bonds. The 41-year average annualized return for a 60/40 portfolio was 9.7%, with a standard deviation of 11.7%.

The 41-year average annualized return for the multi-asset portfolio in this study was 10.5%, with a standard deviation of 10.5%. Blending a wider variety of assets, enhanced performance and reduced volatility compared to an all-stock portfolio or a 60/40 portfolio.

DISTRIBUTION MODE

Then we analyzed the same portfolios in distribution mode-a much harsher environment than accumulation mode. As shown in "Survival Training," (above), each managed to survive intact for all seventeen 25-year periods.

Interestingly, the 60/40 portfolio and the multi-asset portfolio dominated the all-bond portfolio in every rolling 25-year time frame. Moreover, this was during a time from (1970-2010) when bond returns were at all-time highs.

The all-bond retirement portfolio had an average ending balance of $1.77 million over the distribution periods. The range of outcomes for the all-bond portfolio was quite small (see "The Numbers Game," on page 113). The largest ending balance for the all-bond retirement portfolio was $2.6 million and the smallest ending balance was just over $1 million.