Making Your Retirement Portfolio Last Doesn’t Require Blind Luck
I recently read a scary historical fact regarding distributions from our investment portfolios during retirement. In an article from Financial Advisor magazine (yes, there is such a thing, and yes, I actually read it), the author discussed the historical “safe withdrawal rates” for workers retiring at various times in our history. Looking back at what happened in the markets over the last several decades, we can see whose money would last for a several decade retirement. And more importantly, whose would not have lasted!
One sentence in particular caught my eye: “However, at an initial withdrawal rate of about 4.5%, the portfolio of the April 1968 retiree will almost certainly last 50 years, while the portfolio of the October 1968 retiree was exhausted in just 30 years!”
Think about that for a second! If you retired in April 1968, your money would have probably lasted 50 years. But if you retired just six months later, you were out of money in just 30 years. Twenty years worth of retirement income lost by retiring six months later! Of course, at the time neither the April nor October 1968 retiree had any idea what was in store for them.
Scary stuff to consider when trying to decide if you have enough to retire!
Do we have to leave the success of our retirement distributions strategy to dumb luck? Are we left to hope we retired at the “right” time?
Timing is important, of course, but we have no way of knowing in advance how the market will perform over our retirement lifetimes. However, we can build in several contingencies to help us overcome poor market performance during retirement. Of course, none of these contingencies are things we’d LIKE to do, but it’s important to know what to do IF the market returns are dismal. Keep in mind, too, that often these contingencies are only needed for a time…..not as a new way of life. They can act as a bridge to cover the period until the stock market has recovered and you can safely return to your previous distribution strategy.
So what are some options?
Get a job. Ouch. Who wants to get a job after being retired? Well, you do if the market has taken a dive. I’m not suggesting to jump back into a high pressure career with a full-time position. Even part-time work can make a dramatic impact on your withdrawal rate.
For example, assume you needed $40,000 in annual distributions and were planning on a 4% withdrawal rate. Obviously, you would have needed $1,000,000 in your portfolio when you began retirement. Suppose in Year 2 of retirement, the market drops significantly. Because you have a well balanced portfolio of low-cost index funds in both stocks and bonds (you do have such a portfolio, right?), your account balance dropped, but not nearly as much as the major stock indexes like the S&P 500. Nevertheless, your portfolio is now valued at $750,000 (a 25% decline). If you take another $40,000 distribution, your distribution rate would be 5.33% ($40,000/$750,000), way too high for long term success, in my opinion. However, if you found a part-time job making only $833 per month, or $10,000 per year, your distribution would only need to be $30,000, or still 4% of the new lower balance.
Once the market recovers, you can decide whether to keep the job or not.
Cut expenses. Here’s another unpopular answer, but it may be a portfolio saver! Even before retirement you should classify your planned expenses in two categories: essential and discretionary. Essential expenses would include things like food, utilities, basic clothes; items you must purchase. Discretionary expenses are items you could do without if necessary; things like vacations, eating out, etc.
Should the market perform poorly, review those discretionary expenses for items that can be temporarily reduced or removed. Again, just like with the new job, once the market recovers, the fun stuff like vacations can return.
Plan ahead by having cash reserves. Another great idea to help with a market downturn is to have cash reserves. The typical retiree will remove funds from their investment portfolio periodically (annually or quarterly, for example) to fund their upcoming expenses. Having to do this when the market has dropped means you will be forced to sell more shares of an investment to produce the same amount of cash to cover your expenses. Doing so can send your portfolio into a death spiral from which it can’t recover. There simply aren’t enough shares left to grow when the market recovers.
To overcome this threat, many retirees set aside cash to be used when the market drops. Having these funds available means you will not have to sell your investments to generate the cash you need, at least for a year or two or three. All of your investments can stay invested to take advantage of the eventual market recovery.
Of course, if you use some of these funds, they will have to be replaced so they will be available for the next market downturn. Historically, market downturns have been followed by bull markets, for example in 2003 and 2009. Use these strong “up” years to slowly replace the funds used from your cash reserves.
Even the best laid retirement plans can go awry from factors beyond your control. But just because they are beyond control doesn’t mean we’re powerless to address them. By developing reasonable contingency plans – and then implementing them as soon as they are needed – you can increase the odds your portfolio will last as long as you do!
What steps are you taking (or are planning to take) to help your retirement portfolio last?