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Making Your Money Last

Tapping a Portfolio in a Bear Market

New retirees should reduce withdrawals if they want their investments to last a lifetime.

EDITOR'S NOTE: This article was originally published in the August 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.

Timing is everything, and if you're a new retiree, you may be thinking that your timing could not have been worse. It's a big challenge for retirees to recoup their losses when they start tapping investments just as the market moves into bear territory.

But it's not impossible to get your portfolio back on course, as long as you're prepared to exercise some discipline. The best strategy for ensuring that your nest egg will last a lifetime is to reduce your planned withdrawals until the bulls take over, according to a recent study by T. Rowe Price.

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The firm analyzed the probability of a portfolio lasting 30 years if a retiree pursued the rule-of-thumb strategy of withdrawing 4% the first year, with a 3% increase each following year to account for inflation. Assuming that the portfolio was invested in 55% stocks and 45% bonds, the portfolio had an 89% chance of success, based on computer models that ran thousands of market scenarios. However, the odds of lasting 30 years declined if average annualized returns were lower than 5% during the first five years of retirement. For instance, the odds of success dropped to 64% if returns were between 2% and 3%.

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Using this data, the firm analyzed several withdrawal strategies for a fictitious investor who had retired on January 1, 2000, just before the start of the last bear market. If the retiree had a $500,000 portfolio and pursued the rule-of-thumb withdrawal strategy, the portfolio would have declined to $374,096 by the time the market hit bottom on September 30, 2002. At that point, the portfolio would have only a 57% probability of lasting the remaining 27 years.

Retirees in this predicament do have choices. T. Rowe Price assessed four options, based on returns of stock and bond indexes between January 1, 2000, and January 31, 2008. Because of a recovery in late 2007, the eight-year period achieved an overall gain of 34.6%.

Skip Inflation Increases for a While

Christine Fahlund, senior financial planner for T. Rowe Price, says the option that is most suitable for new retirees in the current down market is forgoing the inflation adjustment. "Plan on not increasing your withdrawals for the first few years of retirement, while the market is down," she says.

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In the analysis, the retiree took no inflation adjustments until 2004. By January 31, 2008, the retiree had restored the probability of the portfolio lasting for the entire retirement to 89%.

Another option increased the odds of success to 99% -- but it required the biggest hardship. In this scenario, the retiree continued taking inflation adjustments until the market bottomed out. Then the retiree slashed withdrawals by 25%. The retiree wouldn't start increasing withdrawals until 2008. That would require a big lifestyle change. "It would be a sacrifice that's unnecessary," Fahlund says.

The worst outcome occurred when the retiree fled stocks altogether and switched to an all-bond portfolio. In this scenario, the retiree continued increasing withdrawals for inflation. By 2008, the retiree had $337,753 left -- with only a 5% chance that the portfolio would last for the entire retirement.

"Investors think they'll sell low and lock into bonds," Fahlund says. "When the market goes up, they don't get any of the growth. It's a total disaster." Instead, she says, you should rebalance your portfolio and buy stocks when they're bargains.

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With the fourth option, the retiree continued with the original withdrawal strategy. The portfolio had a 78% probability of success at the beginning of 2008.

The lesson for people retiring into a down market is that there is little to fear about outliving a nest egg, as long as you are prudent early on. And if you haven't retired yet, you could avoid having to take any of these measures by staying in the workforce a little longer.

For more authoritative guidance on retirement investing, slashing taxes and getting the best health care, click here for a FREE sample issue of Kiplinger's Retirement Report.