Saving up enough money to retire comfortably shouldn’t be your only retirement goal. You also need a plan to invest that money to make sure it lasts the rest of your life. Simply withdrawing 4 percent of your portfolio adjusted for inflation each year doesn’t guarantee that your money will last 30 years if it is invested in the stock market. You may need to adjust your withdrawal strategy throughout your retirement depending on how the market performs.
Consider an investor who retired on Jan. 1, 2000 with an account balance of $500,000 invested 55 percent in equities and 45 percent in bonds. A recent T. Rowe Price analysis calculated the odds that this retiree would run out of money over a 30-year retirement using four different spending strategies. Actual returns for stocks and bonds are used for 2000 through 2010 and estimated returns are used thereafter. Here’s a look at which retirement draw down strategies produce the best results.
Withdraw 4 percent per year with inflation adjustments. If the retiree withdraws 4 percent of his portfolio or $20,000 the first year and increases the annual withdrawal amount by 3 percent each year to keep up with inflation, that would normally be a recipe for a successful 30-year retirement. However, once the 2000 to 2002 and 2007 to 2009 bear markets wreaked havoc on his portfolio, the chances of this strategy helping his money to last 30 years dropped from 89 percent before the financial crisis to 29 percent today. “Our research shows that retirees who take a ‘set it and forget it’ approach to their retirement income strategy do so at their own peril, particularly when hit by a bear market,” says Christine Fahlund, a senior financial planner at T. Rowe Price, in the report.
Reduce withdrawals during bear markets. The odds of retirement success are much better if retirees decrease their stock market withdrawals in years when their investments perform poorly. “The last decade has shown that they must remain engaged and sometimes temporarily reduce their expenses in order to maintain a successful withdrawal strategy,” Fahlund says. If this retiree reduces his withdrawals by 25 percent for three years after each bear market bottom, the chances of his money lasting 30 years jumps to 84 percent.
Skip inflation adjustments during bear markets. Skipping inflation adjustments when the stock market declines is another strategy that will help your money last longer. If this retiree takes no annual inflation adjustments for 3 years after each bear market bottom, there is a 69 percent chance that his money will last 30 years.
Exit the stock market. Pulling your money out of equities in years when the market dips locks in your losses. If this retiree switched to a 100 percent bond portfolio after the first bear market bottom on Oct. 1, 2002, he will need to sharply reduce his withdrawal rate or risk running out of money too soon.
T. Rowe Price found that reducing spending during bear markets produced the best results of all the strategies tested, while exiting the stock market completely generally caused retirees to deplete their savings the quickest. The study found no foolproof strategy for getting completely back on track after enduring stock market turmoil shortly after retiring.