Will the Newly Retired Outlive Their Assets?
With the stock and bond markets both selling off this year, here's how the newly retired can make sure their assets last.
Sequence-of-return risk may be an issue for retirees who are currently tapping into their portfolios while both stocks and bonds are losing money. Morningstar's Amy Arnott discusses sequence-of-return risk in today's market.
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. With both stocks and bonds struggling this year and inflation persisting, recent retirees may be concerned about whether they've chosen the wrong time to retire and what they can do to make sure their retirement assets last their lifetimes. Joining me today to discuss the topic is Amy Arnott. Amy is a portfolio strategist with Morningstar.
Nice to see you, Amy.
Amy Arnott: Great. Thanks. Nice to be here.
Dziubinski: The recent meltdown in both the stock and bond markets at the same time may leave retirees thinking, "Oh no, what have I done?" And it makes them vulnerable to something called sequence-of-return risk. So, let's talk a little bit first about what sequence-of-return risk is and why it might be especially pressing for some new retirees today.
Arnott: Sequence of returns is basically the order in which the returns are happening, and it usually doesn't matter if you are someone who is just buying and holding for a long period. What's really going to affect your results is the average return over time. But if you're a retiree who is taking cash out of your portfolio, sequence of returns can be more of an issue, and especially in a case where you have a negative sequence of returns early in retirement. It can be sort of a double whammy because your portfolio value is going down, plus you're taking money out of the portfolio. So, the portfolio is getting smaller, and then you have less assets available to recover when the market eventually rebounds. And as you mentioned, usually this is less of an issue for people who have balanced portfolios with both stocks and bonds. But because both stocks and bonds are down this this year, it has been more of a concern for many people who are recently retired.
Dziubinski: You recently took a look at various different time periods in history when we've seen some market duress, and you looked at what impact these unfavorable patterns of sequence of returns actually had on portfolios. What did you find?
Arnott: I looked at three different periods. One was 1929 to 1932, the second was the bear market in 1973 and 1974, and then I also looked at the technology crash in the early 2000s. These are basically some of the worst periods ever for sequence of returns. And what I found is that even though these were all very difficult times, especially after the 1929 crash, retirees did actually see their portfolios recover eventually. So, despite having a very adverse sequence of returns, they still did not run out of money, in general.
Dziubinski: Can retirees, sort of, breathe a little sigh of relief based on that data thinking, "Oh, OK, you know, maybe this is going to be OK?" And what role might inflation play this time around?
Arnott: Right. So, one problem with looking at previous history is we only have about 96 years' worth of market history to look at. There's no guarantee that things might not be worse in the future, especially if you have an environment where stocks and bonds are both declining for several years, plus you have above-average inflation. But the odds of those three things happening all at the same time are probably relatively low.
Dziubinski: In a recent article you talked about a couple of things that retirees can do to help ensure that their retirement assets will last, given that they're facing some of the sequence-of-return risk. One thing that you mentioned in your article is to employ a Bucket strategy in retirement, which is something our colleague Christine Benz has talked about a lot over the years. So, talk a little bit about what the Bucket strategy is and why it is a good approach for investors, for retirees specifically, to consider, particularly maybe at a time like this?
Arnott: The Bucket strategy basically involves taking your expected withdrawals for the next one or two years and kind of setting those aside in a separate bucket that is in cash or other highly liquid investments. And this can be helpful because you don't have to worry about drawing down from your portfolio in a period when it might be down. So, this can also help protect the portfolio because you have more assets left to recover when the market eventually rebounds.
Dziubinski: And related, you say that retirees should also consider perhaps taking a more flexible approach during a time like this with their portfolio withdrawals in retirement. What are a couple of ideas here about how you might be more flexible as a retiree with your portfolio withdrawal rate?
Arnott: Right. So, the classic rule of thumb that a lot of people follow is the 4% rule, which involves looking at the value of your portfolio, taking 4% of that as your starting withdrawal amount, and then adjusting that amount each year for inflation. But you don't have to be that rigid about it. There are a lot of different approaches you can take. One would be not adjusting your withdrawals for inflation. Another is maybe in years when the portfolio value is down, don't take an inflation adjustment. Another option would be using RMDs, or required minimum distributions, to determine how much you're going to take out of your portfolio, which will usually lead you to a more conservative withdrawal number. And then, there's also the guardrails approach, which basically involves taking slightly higher withdrawals in years when the portfolio value is up or lower withdrawals in years when the value is down.
Dziubinski: Well, Amy, thank you for your time today. This is certainly a challenging time for retirees who need to tap into those portfolios. So, we appreciate your tips.
Arnott: Thanks. Great to be here.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.
Read more: Don't Panic on Sequence of Returns