Maintaining Retirement Resources
Average returns vs. sustainable withdrawal rate…. Or something else.
By: Wayne Johnson
Discussions are often brought to us regarding the appropriate assumptions for investment returns on retirement accounts or the sustainable withdrawal rate that retirement resources can maintain for a lifetime. These two topics appear to be the bottom line for retirement financial success, but history has shown us that a number of other factors also influence financial success in retirement. Most notably the sequence of investment returns can have a substantial impact on the level of income that a retirement nest egg can support, and strategies are available to protect against this risk.
Let’s look to history for an example. An investor that retired at the end of
1972 would have begun drawing on his or her retirement nest egg at a market peak. The S&P 500 then declined by 48% over the next 21 months1. These new retirees were placed in a position of drawing on their investments while the market was depressed at the key point in their retirement lifecycle. The experience of these retirees would have been much different than those that retired at the beginning of 1977. Those retirees would have experienced a substantial market gain during the first two years of their retirement. This environment would have maintained the retiree’s nest egg during those crucial years of retirement.
The 1972 retiree would need to limit their sustainable annual distribution to a starting amount of 4% of the initial retirement nest egg to support a 30 year retirement2. On the other hand the 1977 retiree would have been able to take a 6% beginning distribution and maintain a nest egg for nearly 34 years3. Was this difference because those bad market years between 1972 and 1974 lowered the first retiree’s average return dramatically? Not exclusively. The thirty year return on a balanced retirement portfolio that started at the end of 1972 was 9.9%. The thirty year return on a similar portfolio starting in 1977 was 10.9%4,5. A little better, but not enough to explain the substantially different levels of sustainable distribution. The main difference was the order in which the retirees recognized those market returns.
This idea is supported by the analysis of Dr. Wade Pfau of the American College. Dr. Pfau is one of the leading researchers in the area of sustained retirement income. His work indicates that the three years prior to retirement and the three years following retirement are the most crucial years to a retiree’s financial success.
We are aware of the importance of these years, and we help our clients implement strategies that allow them to safely retire when they want, to insulate themselves from the risk of a falling markets during those early retirement years and to maintain a position that allows them to avoid withdrawing invested assets at depressed prices.
1Syverson Strege & Co. calculation from Yahoo Finance data.
2BlackRock: Informa Investment Solutions as published at www.ameriprise.com/retire/planning-for-retirement/retirement-saving/saving-for-retirement.asp
3Gerstein Fisher Research, Standard & Poor’s Index Services, Ibbotson and Sinquefield as published at https://www.forbes.com/sites/greggfisher/2012/12/05/what-portfolio-withdrawal-rate-can-you-live-with/
4Syverson Strege calculation from Barclay’s Aggregate Bond Index Fact Sheet
5Syverson Strege calculation from S&P Index data from Yahoo Finance