Financial Insights

Retirement Withdrawal Rates and “Sequence of Returns” Risk

Last week, we talked about social security timing and how the decision to delay social security retirement benefits can increase your reliance on your portfolio during the years that you delay.

The below compares the early years of the Smith’s retirement based on taking social security at their full retirement age (FRA) vs. delaying until age 70.

If the Smith’s delay their social security retirement benefits to age 70 vs. claiming at their full retirement ages, then they will have withdraw 5.00% from their assets to cover living expenses each year for the first three years of retirement, which equates to about $166,000 by the time Mrs. Smith starts collecting.   That’s more than 15% of their initial retirement portfolio and may be a risky amount to withdraw, particularly if the first few years of retirement are unfriendly from an investment standpoint.

As we pointed out two weeks ago, the prevailing market environment when you retire is important and can make or break how long your money will last depending on how much you are withdrawing.

There is generally a spending curve in retirement that starts out higher (when we are healthy and active), settles in as we age into a routine and then resumes upward with end of life medical expenses.

While this won’t be the case for everyone, it should make some sense.  What’s less intuitive is that the vast majority of people do not start retirement and then immediately begin a new, static lower rate of spending that continues throughout their retirement.  Most don’t reduce spending overnight and often spend more earlier than might be expected as they prepare for a new life stage.

While we have some control over our spending, it’s important to recognize that we typically continue to spend as if we were working in the early years of retirement and may even spend more as part of relocating/downsizing and adjusting to life after work.

What we can’t control is what the market environment will be when we retire.  Some of you will remember older relatives who were able to satisfy a sustainable withdrawal rate of 4% or 5% simply by owning certificates of deposit or treasury securities.  This is not the case today and an example of something we can’t control.

A strong stock market at the onset of your retirement can put the wind at your back, financially speaking, for the rest of your life.  This was the case if you retired in Jan -1983 (see the below chart), which was following by a strong bull market in the 80s and particularly in the 90s.  So strong, that it would have supported withdrawing almost 10% of your portfolio every year for 28 years and not running out of money.

Past performance is no guarantee of future results. For illustrative purposes only. Analysis examined 776 completed 28-year planning horizons, the first of which began on Jan. 1, 1926, and the last of which began on August 1, 1990, ending July 31, 2018. The bar chart shows the maximum sustainable withdrawal rate at the beginning of each assumed retirement year for a 60% stock/40% bond portfolio. Withdrawal rates and portfolio returns are pre-tax and use the historical rate of inflation.  Source: Morningstar EnCorr, Fidelity, as of August 13, 2018.

Contrast this to retiring in Jan – 1965 or 1966, when a maximum withdrawal rate of 4%, or less than ½ of what worked in 1983, was the most you could withdraw and expect not to run out of money in 28 years.

Consider the following sequence of portfolio returns for the Smith’s:

A couple of good years in the market starting out retirement leaves them with more in their portfolio at the time that their social security retirement benefits have fully kicked in in 2025.  Contrast this with the same returns in a different sequence and they have two-thirds of their starting portfolio value in 2025.

Historically, the US equity market has had a seriously negative sequence of returns only a few times over the past 100 years:  1929-32, 1939-41, 1973-74 and 2000-02.  These were all periods with equity market losses that lasted at least two consecutive years.

So a bad sequence of returns is not inevitable.  In fact, it’s rare.  But it’s important to understand because it can ravage a portfolio and potentially result in running out of money well before you would normally expect.

If you retired in 2000, for example, at age 65 with $1,000,000 and expected to withdraw $40,000 per year (increased by 2% / year to keep up with inflation), then here are the results after 10 years.


Because this sequence was so negative right out of the gate, the portfolio never recovered.  Expanding these calculations out to age 84 leaves about $567,000 in the portfolio, which doesn’t leave much cushion in the back end of the retirement spending curve for extra costs like long-term care late in life.

Keep in mind that most retirees do not have 100% of their retirement portfolio in stocks.  An allocation to bonds remains one of the simplest ways to mitigate sequence of returns risk, smooth out total portfolio returns over time and increases the probability that you’ll keep your equity allocation fully invested during periods of normal market volatility.

If the above retiree started with a 60% stock / 40% bond portfolio in 2000, then it would have bottomed out at a little less than $800,000 in 2008, but rebounded back to about $1,400,000 by age 84.

Sequence of returns risk also highlights the importance of having some “cash” on the sidelines.  Cash is not a good “investment”, but it’s predictable and it can serve a critical role as a source to draw from when markets go negative.  Keeping cash to satisfy at least six months or a year or more of living expenses during a bear market can, like an allocation to bonds, improve the probability that you’ll maintain your equity allocation and allow it to rebound.

Exiting the market or trying to time market moves is one of the most common mistakes that investors  make when fear takes over.   The returns realized during a typical calendar year are typically attributed to just a handful of upside trading days.  Missing out on these days is another risk that can significantly negative impact the long-term performance of your portfolio as well.

The early years of retirement are important in terms of how long you can expect your portfolio to last as a result of sequence of returns risk.   It’s not something that you can control, but it is something that you can plan for.

Recognize that it may take a few years to settle into a retirement spending pattern.  Recognize also that you may even spend more initially.  Keep some extra cash on hand initially for this purpose and in the event that markets are negative soon after your earned income ends.  Keep your withdrawal rate in mind so that you’re not taking more than what may be sustainable over a 20 – 40 year retirement.  And because stock market volatility is inevitable, work with your ACM Wealth advisor to ensure that the allocation to stocks vs. bonds in your portfolio fits your risk tolerance and won’t push you to consider exiting stocks when market volatility occurs.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.


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