Posted by Mike Smith :: January 3, 2009 @ 9:14 amEvery retirement planner will tell you that the market will have its ups and downs. What they probably won’t tell you is that if one of those downs comes right near your retirement, it could drastically affect your retirement plans.
Although the stock market is down significantly over the past year (Dow -39%, S&P 500 -45%, Nasdaq -47%) few retirees should have seen such a dramatic drop. By the time they approach or reach retirement, most people have shifted to portfolios heavier on bonds and other fixed income assets and lighter on equities. Still, a retirement portfolio that’s down 16.5% this year is probably a common scenario, particularly for those who recently retired. I arrived at 16.5% by assuming the portfolio had 70% in fixed income assets that retained their value, and 30% in equities that declined by 45%.
To understand the effect of a 16.5% reduction in your retirement portfolio at the start of retirement, I turned to the FIRECalc, which calculates the likelihood that your money will last for the rest of your life. I started with a retirement portfolio worth $1,250,000, assumed annual expenses of $50,000 (it is generally considered “safe” to withdraw 4% of your portfolio per year and 4% of $1,250,000 is $50,000), estimated 30 years left of life, and entered that 30% of the portfolio was in stocks.
The result? FIRECalc looked at the 107 possible 30-year periods of available historical data, starting with a portfolio of $1,250,000 and taking out $50,000 the first year of retirement, and the same amount after adjustments for inflation each year thereafter. With such parameters there was an 86.0% success rate. This means that in 86% of the periods evaluated, the portfolio would have survived 30 years.
Next, I adjusted the starting balance to $1,002,000. This is the $1,250,000 is started with, minus $50,000 in expenses for the first year, and a decline of 16.5% per our rationale above. I then estimated the success rate of the money lasting 29 years, since the first year of retirement had already been accounted for. The new result? The success rate dropped to 44.4%. One down year at the start of retirement meant that I was significantly more likely to run out of money.
You might argue that in such a scenario I should have adjusted the annual expenses by the declined amount as well to maintain the “safe” 4% withdrawal amount, but that reinforces my point. A large early decline in your portfolio may mean that you have to change your plan for retirement. To avoid this, it’s better to save more or plan to withdraw a smaller percentage. In that case, you’ll be more likely to survive if things go bad and come out much further ahead if they do not.
Have changes in your retirement portfolio forced you to adjust your retirement plans?
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