The number one conversation I find myself having with clients over the past 6-12 months pertains to the sustainability of their retirement portfolio, especially when withdrawals are being taken to help fund income in retirement. The two biggest factors regarding this issue are the rate at which you are withdrawing money and the sequence of returns, specifically during your first few years in retirement. One of these factors you have control over and the other you do not. Let us begin with the factor you control --- withdrawal rates.
Studies have shown that in order to preserve your principal, withdrawals off of your assets should stay in the 3-4% range. With interest rates being so low over the past few years more researchers lean closer to three than four. Withdrawal rates are really highlighted when stock market returns are not so friendly. For example, let’s assume that your account falls 20%. An individual not drawing money off of their account would only need a 25% return over the following three years to get back to break even. However, withdrawing at 4% off of their account would require a 42% return over the following three years, a 6% withdrawal rate would require a 51% return, and an 8% withdrawal rate would require a 60% return.
The silent but impactful one-time withdrawals can cause long term harm if done repeatedly because it leaves less principal to work for you when the markets rebound, and that 6% clip you were taking money out on a yearly basis all of a sudden becomes 7-8%. It is easy to call in and get that extra $10,000 here and $20,000 there, but you add those sums up over a period of time and you could easily have withdrawn an extra 5-10% of your assets. We all have things pop up that are out of our control but need to remain vigilant so these excess withdrawals do not jeopardize our long term outlook. Each client situation is unique and some clients are affected more than others.
The second factor that is out of both your control and our control is the sequence of returns in the market. This sequence has the biggest impact during the first few years of an individual’s retirement. Take for example someone that retired at the beginning of 2007 versus someone that retired at the beginning of 2010. The individual retiring in 2007 would have seen the S&P 500 decline over 50% from peak to trough during the 2007-2009 recession. The individual retiring in 2010 would have seen the S&P 500 average double digit returns in the 2010-2014 timeframe.
In conclusion, staying on top of your yearly withdrawal rates and trying to avoid excess one-time withdrawals can help your portfolio weather the not so good times in the market and help keep you on track to reach your goals.