As friends of our team, you regularly hear us encouraging a long-term outlook. While none of us know what will happen in the next six or twelve months, we’re more confident in long-term trends. This is one of the reasons why we spend so much time trying to understand client priorities and then allocate money based on goals and timelines. We also know that it’s easier to take a long-term outlook while assets are accumulating. Withstanding market volatility is easier when your time horizon is measured in decades as opposed to years or months. As clients get closer to retirement, we’re forced to temporarily shorten our outlook. We become near-sighted. Discussions shift from long-term projections to practical logistics. The decision to retire can be very emotional, stressful and joyful at the same time. It’s a big transition to shift from collecting a paycheck to paying yourself!
As plans unfold, we’re frequently asked, “how much can I take from my portfolio?”
While there is no one-size-fits-all answer to this question, there are certainly potholes to avoid. Experience tells us the immediate transition to retirement—shifting from the accumulation phase to “deaccumulation”—can be a delicate process. From a financial standpoint we need to start considering how withdrawal rates interact with market volatility. We temper our long-term optimism with some caution because short-term fluctuations at this crucial transition can have long-term consequences—a phenomenon known as “sequence of returns.”
“Sequence of returns” refers to the importance of early returns and how they affect long-term success. Imagine a scenario where you have $500,000 and we need $40,000 annually from the portfolio—an 8% return. On face, this might seem like a reasonable expectation assuming we can take some risk. The problem, however, is that we’ve built a plan requiring $40,000 from the portfolio. Now imagine we have a market correction, and the portfolio loses 10% of its value. This might be tolerable if we could wait for a market recovery, but we still need to take $40,000! We’re now forced to take $40,000 from a portfolio that has depreciated to $450,000. We’re left with $410,000 and we need an annual return of 22% the following year just to get back to our starting value. A financial plan that looked sustainable begins to unravel as good options become harder to find. Pivoting to cash only locks-in losses, while ratcheting up the risk to “make it back” exposes us to even more possible downside. Depending on lifestyle, cutting expenses might be off the table. Granted, this is an extreme example. Our hope is that if we do our jobs, none of the families we work with are ever faced with these hard decisions.
Financial planning is as much an art as it is a science. While we have many tools and techniques to help calculate “healthy” distributions, we tend to start our conversation around 3.5% to 4% of total assets. This amount is generally accepted as a sustainable long-term withdrawal rate for a diversified portfolio. The thought is that a 4% distribution rate is less susceptible to falling behind the “sequence of returns” power curve. There are however no hard and fast rules, and we consider many financial and non-financial variables. The retirement plan for someone in their late 50s is going to look different than someone in their late 60s. Some people retire with the expectation that the first few years are going to be a party and will inevitably slow down as they age. As financial planners, we’re not here to keep you from your money, but instead act as a sounding board of experience to guide your decision-making. After all—money is just a tool to enable the rest of your life. Some people want to preserve 100% of their nest egg, while others hope their last check bounces. Sometimes our job is to strike a balance between those two philosophies. We need to optimize the plan for both the near-term and long-term needs. We need to make sure that short-term decisions don’t limit long-term options and volatility doesn’t back us into a corner. We have a myriad of different levers and tools we can use to shape a successful retirement plan, but making mid-course corrections can be difficult because we don’t control all the variables.
We view retirement as a critical transition. Not only is it a massively personal decision, but because it starts the clock on a new multi-decade chapter of your life that we need to plan for. In some ways, retirement is more of a new “starting line” as opposed to the finish line. The financial component is just one facet and getting everyone on the same page is the most important factor for success. We want you to be able to enjoy the fruits of your labor while giving you confidence that we’ve planned for the long term
This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.