This is not a new subject for my column, and despite covering the topic several times in the past I continue to be surprised by many retirees expectations of their investments during retirement. If you expect to experience the same performance once withdrawals start as you did prior to starting withdrawals, your retirement could be impacted and your financial security placed in jeopardy.
A simple example may demonstrate this concern more clearly. After a short-term market decline of 5 percent which has happened 46 times, a portfolio not making distributions requires a 5.3 percent return to recover. However, a portfolio making as little as a 5 percent distribution requires an 11.1 percent return to break-even. That is more than twice the return required than portfolios without distributions. Many retirees hope for and sometimes require distribution rates much higher than 5 percent. Thus, when they experience a market decline, the recovery performance to break-even is even higher.
Short-term market declines of greater than 5 percent have occurred 34 times, each requiring even higher recovery performances to break-even. However, breaking even is generally not the desire of investors. With one year resulting in a loss and a second year for the recovery, the impact is even greater since two years of growth is now missing from the ending portfolio value. Very high returns are then required for a portfolio to recover the loss and the expected growth for both years while continuing to meet annual distributions. The required return may be beyond the capability of your portfolio and demand more risk than you are willing to have in your portfolio.
Avoid stocks altogether?
Your initial thought may be to avoid equities altogether and perhaps be able to avoid the worries of declines in your portfolio. In most cases, you would be trading one worry for another. Many income portfolios can and do experience short-term losses, and thus recoveries still have to be made. More importantly though, income portfolios have greater difficulty in staying ahead of inflation and may not last your lifetime.
Knowing the above facts, the thought of averaging 8 or 9 percent per year and withdrawing 5 or 6 percent for retirement may have once sounded plausible, but add one or two bad years and the once invincible portfolio may start to fall apart. Based upon the this discussion, it may appear when most retirees are seeking less risk, they may actually have to increase their risk to be able to make the desired distributions and stay ahead of inflation.
In addition to the risks discussed and the impact distributions have on returns, there are still additional concerns to manage. This should not be surprising when you consider the changes in our retirement strategies over the last few decades. We have gone from retiring at age 65, collecting Social Security, and in most cases a pension as well, and having a retirement expecting to last only a few years; to retirements starting as early as 50 or 55, and in many cases lasting 30 to 40-plus years. If you are not prepared to meet the many challenges of managing your retirement assets, you should find a professional who understands the issues.
Not every investment professional is prepared to manage retirement assets. While they may have done a great job selecting investments during your accumulation years, managing assets during the distribution period requires focus, experience, and true management. Many investment professionals are a better salesperson than a manager, and thus may not be the advisor to manage your assets during retirement.
All of these topics plus others are covered in a report from one of the major investment companies. If you would like a copy of the report, please send a stamped self-addressed envelope to my address below or your name and email address, and we will forward a copy of the report to you. If you are concerned your retirement assets may not last your lifetime because you are withdrawing 6 percent or more from them annually, or your returns are not keeping pace with your withdrawals and inflation, you should contact our firm for assistance or other professionals in the area who have a high understanding of the impact withdrawals have on returns and retirement portfolios.
HOW TO REACH THE WRITER
Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville TN 37801. Be sure to mark your envelope Money Matters. Doug Horn, CFP, is an area financial planner with more than 21 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.
Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas
and Registered Principal, Branch Office of and
Securities offered through CUE Financial, Member NASD, IPC.