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Retirement Success: Part Planning Part Luck

September 21, 2016

Retirement Success is Part Planning…And Part Luck

The First Few Years of Retirement Can Make or Break a Plan

I often explain to clients how important investment returns during the first few years of retirement can be.  Big losses during the market collapse of 2008 derailed the plans of many recent retirees.  Many were forced to reduce lifestyle expectations or return to work as a result of losses incurred.  Traditional investment advice would counsel investors to stick with their strategy – and that is still true.  But once you begin taking distributions from an account, the math changes dramatically.  It becomes much harder to recover from significant market losses.

Consider the following two hypothetical retirees.  Both start retirement with the same assets. Both enjoy the same 6% average rate of return on their investments over the first 10 years of their retirement.  Both withdraw the same amount each year from their retirement accounts:  $72000 per year.  Each has exactly the same returns over 10 years.  The only difference is that the sequence of returns is reversed.  Lucky Louis has his best returns in the beginning of his retirement, Les the Loser has the misfortune of experiencing his poorest years early in his retirement.  The difference in results over 10 years is astounding!

Even while experiencing the same 6% average rate of return, and even suffering the exact same up and down years as Les the Loser, Lucky Louis comes out in much better shape – through the luck of good timing.

What are the financial planning implications?

We need to plan for bad markets.  Most of us can’t really can’t get around the need to invest.  If we don’t, inflation is sure to ravage our account values over the course of a 25 year retirement.  But we need to be cognizant of the fact that sooner or later markets will serve up some difficult years.  And we have just learned that “sooner or later” makes all the difference in the world!!  There are many strategies to cope with this reality.  Some advocate a bucket approach, in which retirees will draw assets for short term needs from safe cash accounts, while investing the remainder of assets more aggressively.  Others will stress diversification of an overall portfolio, in an attempt to reduce risk in the entire portfolio.  There are merits to each approach – but pretending markets will keep going up year after year is not a good plan.

Retirees need to be flexible in their spending plans.  If Lester was planning to spend $10,000 per year for travel expenses – he might want to rethink that budget item after his first year of investment performance.  If he reduced spending in these first two down years, he would see a somewhat healthier result.

Third, don’t panic.  Lester has every right to be nervous after year 2.  But let’s consider what would have happened to Lester’s portfolio if he panicked after year 2 and moved all his assets to cash.  The result is even worse than the original scenario.  By year 10 he has run out of money altogether.   This is why working with a seasoned and experienced financial planner can make a huge difference.  It is a lot easier, with some emotional distance, for those of us who have been through a market panic or two to provide sound counsel during times of distress, and help Lester avoid missteps which could turn an unfortunate situation into a complete disaster!