As you approach retirement, you have a difficult decision to make – reallocate your assets to align with a more risk-averse profile for stability or to keep your funds invested in high-growth assets such as stocks. Each decision has its own issues. By purchasing more bonds, you’re reducing the potential negative impact on your portfolio that a market downturn could bring. Still, the return may not keep up with inflation and your withdrawal rate. An alternative is to remain invested in risky albeit promising stocks with growth potential. But is it a risk worth taking?
This article outlines the potential benefits of staying invested in high-growth, risky assets and the potential negative scenarios, such as the negative sequence of returns risk.
The Negative Sequence of Returns Risk
Let’s imagine a scenario where John, your typical retirement saver, albeit a fictitious one, has $1,000,000 invested in the S&P 500 and plans to retire at age 65. However, the year he begins making withdrawals, the stock market crashes. How will his savings fare?
How It Is Calculated
Initial Withdrawal: At the beginning of each year, John withdraws a fixed amount from his savings for his living expenses. Let’s say he withdraws $50,000 annually.
Market Impact: After the withdrawal, the remaining balance is subjected to the market’s performance. If the market experiences a downturn, such as a negative 10% return, John’s already reduced savings take a further hit.
Compound Effect Over Time: Each subsequent year, the process repeats—John withdraws the same amount, and the remaining balance is affected by the market. If the market continues to perform poorly in the initial years of his retirement, John’s savings could diminish much faster than if the poor returns occurred later.
|
Year
|
Beginning Year Balance
|
Return
|
Withdrawal Rate
|
|---|---|---|---|
|
1
|
$853670.00
|
-10.14
|
5%
|
|
2
|
$698871.43
|
-13.04%
|
5%
|
|
3
|
$497230.18
|
-23.37%
|
5%
|
|
4
|
$565209.50
|
26.38%
|
5%
|
|
5
|
$561526.83
|
8.99%
|
5%
|
|
6
|
$526872.64
|
3.00%
|
5%
|
|
7
|
$541822.69
|
13.62%
|
5%
|
|
8
|
$509184.03
|
3.53%
|
5%
|
|
9
|
$282444.10
|
-38.49%
|
5%
|
|
10
|
$286952.24
|
23.45%
|
5%
|
|
11
|
$267234.74
|
12.78%
|
5%
|
|
12
|
$217234.74
|
0
|
5%
|
|
13
|
$189660.91
|
13.41%
|
5%
|
|
14
|
$181000.54
|
29.60%
|
5%
|
|
15
|
$145921.51
|
11.39%
|
5%
|
|
16
|
$95221.28
|
-0.73%
|
5%
|
|
17
|
$49535.39
|
9.54%
|
100%
|
|
18
|
0
|
0%
|
0%
|
After 17 years, John’s investment savings are gone. The series of negative market returns in the first few years of retirement significantly impacted its growth momentum in the face of ongoing and sizeable yearly withdrawals. In fact, if John had years of market growth in the beginning, and those years of negative market returns occurred in year 12 instead, he’d be left with $479,562 in year 17.
What if he had just cashed out his savings rather than staying invested in stocks? According to 2024 tax brackets, as per Tax Intuit, he’d be left with about $670,000 as a single filer, all other factors being equal. With a $50,000 yearly income, he’d run out of money in less than 14 years – quite a bit sooner than staying invested. He also runs the risk of severely affecting his Medicare premiums, and in retirement, every dollar counts.
It’s important to note that we haven’t factored in inflation. $50,000 after 17 years leaves John with a purchasing power of only about $31,000, assuming a 3% inflation rate. Even if he doesn’t run out of money, his savings will hardly cut it.
Other issues could also arise that would severely impact his savings, such as health care costs not covered by Medicare or health insurance, an accident, or any other financial emergency. Removing a sizeable sum at any time during retirement will significantly reduce the ability of his savings to recover.
Keep in mind that this is a simplified and hypothetical scenario. We assume John decided to make the risky decision of staying solely invested in the S&P 500. Additionally, individual stocks and other index funds may experience different rates of return, which can be higher or lower than the S&P 500’s historical returns. Your personal financial situation is likely much more complex.
What Are the Solutions?
In our example, John stuck with a static withdrawal rate of 5% throughout his retirement journey. In a period of stock market downturns or high inflation, he could adjust his withdrawal rate and rely on other financial products and Social Security to help give his savings enough momentum to pull through intact while maintaining his lifestyle. Hopefully, he optimized his Social Security claiming strategy beforehand.
As for other financial products, John could purchase a universal life insurance policy. From that policy, he could potentially take loans against his death benefit to help supplement his income in times of need. Alternatively, he could purchase an annuity that would provide guaranteed, fixed-income payments later in life after his savings are depleted – particularly useful if he lives a long life.
Final Thoughts
As this article shows, retirement is so much more than saving as much as possible and relying on that nest egg to make it through retirement. You have to consider rates of return, asset allocation, Social Security, Medicare premiums, taxes, withdrawal strategies, health issues, Required Minimum Distributions, … the list goes on. That’s why sitting down with a financial professional is so vital: they can help you explore all possible routes and strategies to discover what makes sense for your retirement goals and needs.
The professionals at CPA Retirement Solutions would be more than happy to discuss your financial strategy and educate you on possible solutions. If you’d like to talk with one of our professionals, don’t hesitate to click the button below and schedule a consultation with an expert who cares.
