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Retirement Income Management

October 30, 2018

Timing is more important than many realize.

Investor truism: Time in the market is more important than timing the market.

For those with a long-term time horizon, volatility in the financial markets is relatively unimportant. Imagine that a portfolio has an average 10-year return of a modest 5%, but the yearly returns are 25%, 18%, 3%, -4%, -28%, -2%, 8%, 10%, 12%, and 8%. Does it matter when the bad years occur?

It does not.   

The table below shows what would happen to $500,000 over ten years. On the left, the bear market comes early, pushing the portfolio into loss territory, from which it recovers only after eight years. Putting the bull market first, as on the right, causes the portfolio to soar, but when the inevitable bear market ensues, the losses apply to a much higher base. After ten years, the portfolios arrive at the same final total.

For savers, the sequence of returns makes no difference at all. During the accumulation years of the financial life cycle, the important factor is being invested for as long as possible, to be confident of participating when the markets enjoy good years. Although one might hope to move the portfolio to cash at the top of the market, to avoid the bear market losses, very few investors have been able to do that successfully. Studies have shown that the most important market moves happen on just a very few days. The risk of market timing is being out of the market when another major uptick occurs.   

Two Paths

Year

Bear Market Early

Bull Market Early

Return

Value

Return

Value

 

 

$500,000

 

$500,000

1

-28%

$360,000

25%

$625,000

2

-4%

$345,600

18%

$737,500

3

-2%

$338,688

8%

$796,500

4

8%

$365,783

12%

$892,080

5

3%

$376,757

10%

$981,288

6

10%

$414,432

3%

$1,010,727

7

12%

$464,164

8%

$1,091,585

8

8%

$501,297

-2%

$1,069,753

9

18%

$591,531

-4%

$1,026,963

10

25%

$739,413

-28%

$739,413

 

A very different story for retirees

Retirees are concerned about outliving their financial resources, and with good reason. There are not many options for a retired person to boost his or her income other than selling assets. What is a sustainable withdrawal rate for a retiree?

Timing is everything, in trying to answer this question. If retirement commences during good economic times, the nest egg has a good chance of lasting decades.

Let’s begin with the $739,413 that was saved in the earlier example. Assume that the retiree will need to draw down $50,000 annually, less than 7% of the account’s value. If there is a bull market when the withdrawals begin, the account will continue to grow despite the partial consumption, as shown in the table below.

After taking $500,000 out of the account over ten years, a retiree who begins taking distributions during a bull market still has $667,639 to work with for the balance of the retirement.

However, a colleague who retires during a down market is not so fortunate. At the 10-year mark, this retiree’s portfolio is just one-third the value of that of one who retired during a bull market. The years of high returns are applied to a much lower account balance.

Divergence

Year

Bear Market Early

Bull Market Early

Return

Withdrawal

Value

Return

Withdrawal

Value

 

 

$739,413

 

 

$739,413

1

-28%

$50,000

$482,378

25%

$50,000

$874,267

2

-4%

$50,000

$413,082

18%

$50,000

$981,635

3

-2%

$50,000

$354,821

8%

$50,000

$1,010,165

4

8%

$50,000

$333,207

12%

$50,000

$1,081,385

5

3%

$50,000

$293,203

10%

$50,000

$1,139,524

6

10%

$50,000

$272,523

3%

$50,000

$1,123,710

7

12%

$50,000

$255,226

8%

$50,000

$1,163,606

8

8%

$50,000

$225,644

-2%

$50,000

$1,090,334

9

18%

$50,000

$216,260

-4%

$50,000

$996,721

10

25%

$50,000

$220,325

-28%

$50,000

$667,639

 

What can one do?

The choice of a start date for one’s retirement will be influenced by many personal factors. The health of the financial markets is typically low on the list of concerns, but these tables suggest that perhaps it shouldn’t be. There are steps that can be taken to protect against market vagaries.

  • Augment capital. Sell the house; move to smaller quarters; pocket $250,000 worth of capital gains tax free ($500,000 for couples) to supplement retirement capital.
  • Reduce spending. Someone who already has retired doesn’t have the luxury of becoming “unretired.” Unpleasant though it may be, when the markets head south, some spending plans may have to be deferred or eliminated.
  • Smooth portfolio volatility through sound asset allocation. By balancing portfolio assets among a variety of investment classes—large stocks, small stocks, short-term bonds, long-term bonds, and so on—expected returns may fall within a narrower range. The lowest lows will be avoided—along with the highest highs—and the risk of outliving one’s money may be reduced.

We can help you

Unbiased investment management is an integral part of our service as trustee. But you don’t need to fund a trust to be able to call upon our professional expertise. We manage investment portfolios for a fee for individuals and families in a wide variety of situations.

This month, why not schedule a meeting with us to learn more?

© 2017 M.A Co. All rights reserved.

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