Retirement Planning

Choice of Retirement Start Date

Timing is more important than many realize.

Investor rule of thumb: Time in the market is more important than timing the market. Here’s evidence for that statement. Start with the following set of hypothetical returns:

Hypothetical Returns

Year Return
1 -28%
2 -4%
3 -2%
4 8%
5 3%
6 10%
7 12%
8 8%
9 18%
10 25%

Although there is a wide variation from year to year, ranging from a 28% loss to a 25% gain, the average return for these ten years comes to a modest 5%. What would happen to $100,000 invested at these rates?

Saving begins during a bear market:

Year Return Value
    $100,000
1 -28% $72,000
2 -4% $69,120
3 -2% $67,738
4 8% $73,157
5 3% $75,351
6 10% $82,886
7 12% $92,833
8 8% $100,259
9 18% $118,306
10 25% $147,883

Would it be better if you could reverse the sequence of returns? How much more money would you end up with if you could start off with that stellar 25% year?

Saving begins during a bull market:

Year Return Value
    $100,000
1 25% $125,000
2 18% $147,500
3 8% $159,300
4 12% $178,416
5 10% $196,258
6 3% $202,145
7 8% $218,317
8 -2% $213,951
9 -4% $205,393
10 -28% $147,883

For savers, the sequence of returns makes no difference at all. Yes, in the second example the nest egg breaks through the $200,000 level, but that evaporates under the weight of the large loss. 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.

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? At what withdrawal rate can a retiree be reasonably confident that he or she won’t exhaust the available retirement capital?

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. But retirement during a down year can wreak havoc on a retirement portfolio.

Let’s begin with the $147,883 that was saved in the earlier example. Assume that the retiree will need to draw down $10,000 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. The following examples use the same sequence of investment returns as the savings examples.

Withdrawals begin during a strong market

Year Return Withdrawal Value
      $147,883
1 25% $10,000 $174,853
2 18% $10,000 $196,327
3 8% $10,000 $202,033
4 12% $10,000 $216,277
5 10% $10,000 $227,905
6 3% $10,000 $224,742
7 8% $10,000 $232,721
8 -2% $10,000 $218,067
9 -4% $10,000 $199,344
10 -28% $10,000 $133,528

After taking $100,000 out of the account over ten years, this retiree still has $133,000 to work with for the balance of the retirement. However, a colleague who retires during a down market is not so fortunate.

Withdrawals begin during a weak market

Year Return Withdrawal Value
      $147,883
1 -28% $10,000 $96,476
2 -4% $10,000 $82,616
3 -2% $10,000 $70,964
4 8% $10,000 $66,641
5 3% $10,000 $58,641
6 10% $10,000 $54,505
7 12% $10,000 $51,045
8 8% $10,000 $45,129
9 18% $10,000 $43,252
10 25% $10,000 $44,065

At the ten-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. When even modest withdrawals are coupled with poor investment return, a retirement nest egg can shrink quickly.

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.

The concern becomes acute when the market suffers a major retreat after setting new highs, as happened last year. There are steps that can be taken to protect against market uncertainties.

  • 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? Call us at 757-6300 to schedule a meeting with a financial advisor today, or click here to learn more about our services.

 

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