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.
By Kathryn A. Walson, Staff Writer, Kiplinger's Retirement Report
October 1, 2008
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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%.
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.
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.
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.
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Reader Comments (4)
Posted by: Victor Paganucci at 10/01/2008 05:39:09 PM
This is all very bad advice. It's so "1980's. It clearly doesn't work. The market has not had "growth" (ha) in 10 years. In addition, we have had 2 ugly bear markets in the last 10 years... If you can retire when you want, your plan should include assets of at least 20% above "what you need". History says that there will be severe bear markets every 5 years or so. Not many retirees can afford to see their assets fall 20-30% every 5 years or so. It simply ruins their life. My advice. Stay safe. Have no more than 20% of assets in equities. And then only withdraw the dividends. The rest should be in quality income producers. Bonds, bond funds, tresuries, CD's, stable value funds and fixed and immediate annuities. Then limit total withdrawals to 3to 3.5% If a person in retirement needs his/her portfolio to live, I guarantee a nest egg that is heavy in stocks will not work, and will ruin the persons life. My plan works........yours doesn't.
Posted by: paul at 10/06/2008 11:35:31 AM
Victor, I agree with your post.What would you suggest for a fund or funds for the 20% equity exposure? best wishes, Paul
Posted by: Bob at 10/07/2008 01:57:32 AM
I agree this is bad advice. I retired 10 years ago and shortly after the dot.com bust I bailed out of the stock market almost completely. I'm now 75% in bonds, 20% cash, 5% dividend paying stocks. A buy and hold stock strategy using the old conventional wisdom of 60% stocks and 40% bonds is a disaster. Amazing that investment advisors still sell this worn out concept after seeing what the stock market did over the last 10 years. Using my allocation, I still have 85% of my nest egg after 10 years of retirement. I currently withdraw 4.3% per year and live on 80% of my inflation adjusted pre-retirement income.
Posted by: hlauth at 11/25/2008 02:24:03 AM
I see nothing about RMD from IRAs, given the steep drop in stock prices since 12/31...and, the high value on that date compared with what we have to withdraw by 12/31/08...chatter, yes..but you don't addreess the problem, or a possible solution...what about taking the RMD from your traditional and then returning it within 60 days, if the Feds waive the old rule???