Coping Strategies When Retiring Into a Bear Market

Retirement preparedness can plummet if withdrawal amount exceeds portfolio returns.

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Retiring during a year when stocks are down can have disastrous consequences for your nest egg. Investments that dip into the red during the first five years of retirement drastically increase your chances of running out of money during a 30-year retirement, a recent study found.

If an investor who retires with a $500,000 portfolio (invested 55 percent in equities and 45 percent in bonds) withdraws 4 percent of his portfolio ($20,000) the first year and increases that amount by 3 percent each year to keep up with inflation, the investor has an 89 percent chance of having enough left in the portfolio to last 30 years, according to a T. Rowe Price analysis.

But if the portfolio had an average return of less than 5 percent in the first five years of retirement, the probability of being able to sustain the same withdrawals over 30 years can drop as low as 43 percent, T. Rowe Price calculated. "If you are taking out more than you are earning from your portfolio in the early years of retirement, you are probably digging a big hole in your plan," says James Tzitzouris, an investment analyst for the firm who conducted a simulation study.

Here's how low rates of return in the first 5 years of retirement affect how long your money will last.

Annualized return in the first 5 years of retirement Chance you won't run out of money over 30 years
4-5 percent 74 percent
3-4 percent 69 percent
2-3 percent 64 percent
1-2 percent 57 percent
0-1 percent 51 percent
less than 0 43 percent

Source: T. Rowe Price Associates calculations, 2008.

Note: This chart shows the probability of not running out of money over a 30-year retirement for an investor who withdraws 4 percent of his portfolio the first year and increases the withdrawal amount by 3 percent each year to reflect inflation.

Assumptions: Analysis assumes a portfolio composed of 55 percent stocks and 45 percent bonds. Taxes and required minimum distributions are not accounted for.

The most obvious strategy to cope with a down market is to keep working until the market recovers. But if that's not an option, Tzitzouris tested four strategies for weathering a bear market in your early retirement years: continuing to take withdrawals as planned; lowering the withdrawal amount; taking no inflation adjustments; and switching to a 100 percent bond portfolio.

"In this study, the retiree who kept the asset allocation intact but reduced withdrawals for a few years did well, but the investor who panicked and switched to 100 percent bonds badly hurt the chance of having enough money for retirement by getting out of equities just as the equity market was poised to recover," summarizes Christine Fahlund, a senior financial planner with the firm.

Here's how to know if you are financially ready to retire.