retirement starting to tempt you?
you peer into your 401(k) and think: "Not bad.
Should I go for it?"
youíve even run some numbers on a calculator to assure
yourself that you can remove 4 or 5 percent of your
savings each year for living expenses, or your financial
adviser confirms you have plenty of money to last to age
90.You know about the so-called 4 percent rule ó the
rule financial planners use to make sure you donít
spend too much and run out of money too early in
figure you will live within the rule, but stretch it a
bit ó maybe withdrawing 5 percent of your savings each
year. You tell yourself: "What could go wrong? I
can take this leap."
just one thing. Itís called sequence of returns. And
it can go wrong. If it does, instead of your money
lasting through retirement, it may run out while youíre
still feeling pretty good and enjoying life. This
potential disaster increasingly is getting attention
from financial advisers. Financial planner Michael
Kitces told a ballroom full of advisers at the
Retirement Income Summit in Chicago this month that they
cannot let their clients ignore the risk.
a nutshell it goes like this: Typically, when people
look at their retirement money with a financial planner,
they figure they will invest the money and make a
return, or a gain, on their savings every year. So as
they go through retirement, each year they will remove
some money to live on, but the remaining money will be
invested and presumably grow.
retirement funds start to dwindle. To keep them from
dwindling too fast, retirees are often told to start
with a balanced portfolio ó perhaps putting 60 percent
into stock funds and 40 percent into bonds. If they are
more cautious, they may go to 50-50.With these
investments, history suggests they should average an 8
percent gain per year. And if they withdraw no more than
4 or 5 percent each year for living expenses, models
based on history suggest the savings should last them 30
thereís a major problem with averages. History is made
up of many different periods in time, and although
balanced investments have earned 8 percent annually on
average since 1926, you can never expect the average to
happen in a single year or even a few years. Sometimes
there are nasty stretches. During the best periods in
history, the return has been 32 percent for a 50-50
mixture of stocks and bonds in a single year. During the
worst, people have lost 22.5 percent in one year,
according to Vanguard.
you are the unlucky soul who happens to retire just as
one of the losing periods pops up and shrinks your
savings just when you need the money. Surprisingly, if
you are hit by a bad spell later in retirement, you
should be fine because you will have grown your money
very well during your early years of retirement, Kitces
if the nasty period happens soon after youíve retired,
the results could be devastating, and financial planners
need to have their clients plan for horrible sequences
rather than just assuming they can count on average
an example pulled from history by David Blanchett, head
of retirement research for Morningstar Investment
Management. A 65-year-old retires at the beginning of
1972 with $1 million and she feels confident about
retirement. Sheíll take $50,000 a year out of her
savings to cover living expenses and each year adjust it
up slightly to cover inflation.
stock market is reassuring. That year it climbs 19
percent, and with bonds, her balanced mixture of
investments grows 13.4 percent. By the end of the year,
she has about $1.04 million, even though she removed
$50,000 for living expenses.
along comes trouble. After a period of great enthusiasm
about stocks, they drop 14.6 percent the next year. The
woman, who is just one year into retirement, loses about
6.9 percent on her stock and bond mixture. The next
year, the pain continues. Stocks drop 26.5 percent and
her combination of stocks and bonds lose 13.9 percent.
By the end of 1974, she has only $614,880 left in
dwindling much faster than the averages suggested it
would and yet, she continues to take out funds for
living expenses. Over the next few years, stocks are up
and down and flat. One year they climb as much as 25
percent, another they lose 3.3 percent. But instead of
lasting 30 years ó as her pre-retirement calculations
suggested they would ó she runs out of money at age
88, which is troubling since 45 percent of people live
hereís the strange part. If the two bad investment
years that wreaked havoc with the womanís money had
come late in retirement rather than at the outset, she
would have had about $2 million at age 95.
all a matter of timing, and bad times in the stock
market canít be predicted accurately. There is one tip
for spotting possible trouble, however. When stocks and
bonds get overly expensive, they tend to decline or earn
very small returns for a few years.
we have been in one of those periods, Kitces said
retirees thinking about retirement now could be
vulnerable to a decline or just measly returns. But
guessing when stocks will go down is impossible, and
sometimes even when expensive, they can stay that way
the solution? Itís not to try to guess when the market
will turn cruel. Even the best pros get that wrong.
Instead, the key is to think at the outset of retirement
whether you would have enough in Social Security,
pensions or maybe annuities or money from a temporary
job to cut back spending in a tough period. That allows
time to let your stock investment sit untouched for a
time so it can grow again once the stock market comes
out of its funk.
suggests thinking about keeping your savings in distinct
theoretical buckets. One would contain enough cash for
three years so you could avoid tapping other investments
in a bad spell. Another would contain four to 10 years
of bonds that could produce income that could be tapped
without touching stocks.