EDITOR'S NOTE: This article was originally published in the August 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.
Timing is everything, and if you're a new retiree, you may be thinking that your timing could not have been worse. It's a big challenge for retirees to recoup their losses when they start tapping investments just as the market moves into bear territory.
But it's not impossible to get your portfolio back on course, as long as you're prepared to exercise some discipline. The best strategy for ensuring that your nest egg will last a lifetime is to reduce your planned withdrawals until the bulls take over, according to a recent study by T. Rowe Price.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
| Row 0 - Cell 0 | Retiring in Volatile Times |
| Row 1 - Cell 0 | Retire on Time? Yes, You Can |
| Row 2 - Cell 0 | An Income Stream to Last a Lifetime |
The firm analyzed the probability of a portfolio lasting 30 years if a retiree pursued the rule-of-thumb strategy of withdrawing 4% the first year, with a 3% increase each following year to account for inflation. Assuming that the portfolio was invested in 55% stocks and 45% bonds, the portfolio had an 89% chance of success, based on computer models that ran thousands of market scenarios. However, the odds of lasting 30 years declined if average annualized returns were lower than 5% during the first five years of retirement. For instance, the odds of success dropped to 64% if returns were between 2% and 3%.
Using this data, the firm analyzed several withdrawal strategies for a fictitious investor who had retired on January 1, 2000, just before the start of the last bear market. If the retiree had a $500,000 portfolio and pursued the rule-of-thumb withdrawal strategy, the portfolio would have declined to $374,096 by the time the market hit bottom on September 30, 2002. At that point, the portfolio would have only a 57% probability of lasting the remaining 27 years.
Retirees in this predicament do have choices. T. Rowe Price assessed four options, based on returns of stock and bond indexes between January 1, 2000, and January 31, 2008. Because of a recovery in late 2007, the eight-year period achieved an overall gain of 34.6%.
Skip Inflation Increases for a While
Christine Fahlund, senior financial planner for T. Rowe Price, says the option that is most suitable for new retirees in the current down market is forgoing the inflation adjustment. "Plan on not increasing your withdrawals for the first few years of retirement, while the market is down," she says.
In the analysis, the retiree took no inflation adjustments until 2004. By January 31, 2008, the retiree had restored the probability of the portfolio lasting for the entire retirement to 89%.
Another option increased the odds of success to 99% -- but it required the biggest hardship. In this scenario, the retiree continued taking inflation adjustments until the market bottomed out. Then the retiree slashed withdrawals by 25%. The retiree wouldn't start increasing withdrawals until 2008. That would require a big lifestyle change. "It would be a sacrifice that's unnecessary," Fahlund says.
The worst outcome occurred when the retiree fled stocks altogether and switched to an all-bond portfolio. In this scenario, the retiree continued increasing withdrawals for inflation. By 2008, the retiree had $337,753 left -- with only a 5% chance that the portfolio would last for the entire retirement.
"Investors think they'll sell low and lock into bonds," Fahlund says. "When the market goes up, they don't get any of the growth. It's a total disaster." Instead, she says, you should rebalance your portfolio and buy stocks when they're bargains.
With the fourth option, the retiree continued with the original withdrawal strategy. The portfolio had a 78% probability of success at the beginning of 2008.
The lesson for people retiring into a down market is that there is little to fear about outliving a nest egg, as long as you are prudent early on. And if you haven't retired yet, you could avoid having to take any of these measures by staying in the workforce a little longer.
For more authoritative guidance on retirement investing, slashing taxes and getting the best health care, click here for a FREE sample issue of Kiplinger's Retirement Report.
-
Here's How To Get Organized And Work For YourselfWhether you’re looking for a side gig or planning to start your own business, it has never been easier to strike out on your own. Here is our guide to navigating working for yourself.
-
How to Manage Risk With Diversification"Don't put all your eggs in one basket" means different things to different investors. Here's how to manage your risk with portfolio diversification.
-
457 Plan Contribution Limits for 2025Retirement plans There are higher 457 plan contribution limits for state and local government workers in 2025 than in 2024.
-
What Does Medicare Not Cover? Seven Things You Should KnowHealthy Living on a Budget Medicare Part A and Part B leave gaps in your healthcare coverage. But Medicare Advantage has problems, too.
-
13 Smart Estate Planning Movesretirement Follow this estate planning checklist for you (and your heirs) to hold on to more of your hard-earned money.
-
Medicare Basics: 11 Things You Need to KnowMedicare There's Medicare Part A, Part B, Part D, Medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare — and much more.
-
The Seven Worst Assets to Leave Your Kids or Grandkidsinheritance Leaving these assets to your loved ones may be more trouble than it’s worth. Here's how to avoid adding to their grief after you're gone.
-
SEP IRA Contribution Limits for 2024 and 2025SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $69,000 in 2024 and $70,000 in 2025..
-
Roth IRA Contribution Limits for 2024 and 2025Roth IRAs Roth IRA contribution limits have gone up. Here's what you need to know.
-
SIMPLE IRA Contribution Limits for 2024 and 2025simple IRA The SIMPLE IRA contribution limit increased by $500 for 2025. Workers at small businesses can contribute up to $16,500 or $20,000 if 50 or over and $21,750 if 60-63.
