In Retirement Planning, Consider the Entire Journey

Editor’s note: This is part one of a three-part series that takes a look at planning for retirement during the “fragile decade.”

The fragile decade is the wonderfully exhilarating time that spans the last five years of working and the first five years in retirement. It’s also the period that could blow up your whole retirement plan.

If you have not yet reached your fragile decade, pay even closer attention, because this is a glimpse into your financial future — a future that you can be better prepared to take on when it arrives faster than you can imagine.

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Think about mountain climbing. The journey begins with careful planning for the ascent up the mountain to eventually attain the summit. But mountain climbing isn’t only about standing on the peak, it’s also about getting back down safely. Mountain climbers often say that planning and executing the descent is more involved and difficult than the journey up.

And just like mountain climbing, both stages of our financial plan, the ascent (accumulation) and descent (withdrawal), are best executed when planned out before ever stepping foot on the mountain.

Some investors are obsessively focused on the ascent — accumulating wealth, getting to the peak and triumphantly quitting their job. But recognize this: We must plan for not only getting to the withdrawal stage, but also getting through it. The goal of your investment portfolio isn’t to build the tallest mountain of assets, but to provide you with an acceptable monthly cash flow that you won’t outlive — a comfortable, stress-reduced walk around and down the mountain.

Once you’ve won the game, stop playing

Please notice that nowhere in this goal do we talk about beating the market. As you approach your fragile decade and put your focus on covering your monthly expenses, you should realize that success is best measured by meeting your goals, not beating some arbitrary market benchmark.

But ignoring those around you isn’t always easy. As John Pierpont Morgan once observed, “Nothing so undermines your financial judgment as the sight of your neighbor getting rich.” So, hang tough and continually remind yourself: Don’t try to keep up with the Joneses or beat the market. Take a deep breath and realize the only person you need to beat tomorrow is the person you are today.

“Markets can remain irrational longer than you and I can remain solvent.”

— A. Gary Shilling

One of the most significant reasons that the fragile decade can be so perilous is the effects of sequence risk. This is the danger that the order (i.e. sequence) of market returns will have a material negative impact on your planned withdrawals. Why? Because compound interest works with you during the accumulation stage and against you in the withdrawal stage. Let’s look at a simple example to explain the math.

Assume you retired at age 57 with $1 million at the beginning of 2000. You started with an annual withdrawal of 4% of your portfolio ($40,000), which you increased each year by 3% because of inflation. Sequence 1 in the chart below shows that by 2020, at 77 years young, you would have enough to cover just two more years of withdrawals (and this assumes you had no unexpected expenses over the 20 years).

Sequence 2 has identical assumptions, except that the sequence of the returns is different (I simply reversed the order of the returns). You can see that in both sequences, you achieved the same average annual return (7% simple average) and total withdrawals ($1.1 million). In Sequence 2, however, you would have reached age 77 with almost $1.8 million remaining in your portfolio — $776,000 more than you retired with. The sequence of returns matters!

Note: For those of you who think the hypothetical returns in the above example look far-fetched, Sequence 1 lists the actual annual returns of the S&P 500 Index in chronological order.

The above period, 2000-2020, illustrates the negative compounding impact on withdrawals of down markets especially early on. But to be fair, there are plenty of other periods where the results would not be disastrous and, in fact, could grow the portfolio, or allow you to withdraw more, like Sequence 2. That’s why it’s a risk — you just don’t know what kind of sequence you’re going to be dealt as you enter the withdrawal stage.

Like with the game of chess, see the whole board

While planning for your fragile decade, remember that bull and bear markets are beyond your control — simply the luck of the draw. So, it’s crucial to concentrate on factors that are within your control: the amount of your monthly contributions and withdrawals, setting realistic goals, making informed investment choices and adhering to a dynamic planning process.

In the next article (part two), we will explore goals-based planning — an idea that helps us get beyond simply focusing on how much risk we can stomach. In part three, we pull it all together and offer up some specific ideas for mitigating the impact of sequence of return risk and protecting the retirement cash flow you have diligently worked to achieve.

Part two of this series, arriving next Wednesday, will be about goals-based retirement planning.

As always, invest often and wisely. Thank you for reading.

This content is for informational purposes only. It is not intended to be, nor should it be construed as, legal, tax, investment, financial or other advice.

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