Many of us grew up with the concept that making regular, periodic contributions to our retirement account was a sound investment strategy. The idea was that, in a fluctuating market, regularly investing a set amount would enable an individual to buy more shares when prices were low and fewer shares when prices were high. 1
Does this mean that taking regular, periodic withdrawals during retirement makes similar good sense?
Actually, it can be quite problematic.
Systematic withdrawals do the precise opposite of systematic investments by selling fewer shares when the price is high and more shares when the price is low. This, in effect, reduces the number of shares that may be able to participate in any subsequent market recovery.
Here‘s an example.
In the accumulation phase, if a portfolio falls by 25%, it will require approximately a 33% return to get back to its pre-decline value. 2
In the distribution phase, if you withdraw 5% of your portfolio for income and suffer the same 25% market decline, you would need to see a 43% market rebound to get back to pre-decline value. 2
Sequence of Returns
In the accumulation phase, investors tend to focus on average annual rates of return, less on the sequence of the returns. If you‘re a buy-and-hold investor, ignoring short-term fluctuations may be a sound long-term approach.
If you are in retirement, however, you absolutely care about the sequence of the annual returns.
For instance, comparable portfolios might deliver the same average annual return over a 20- or 30-year period, but they could have radically different outcomes in terms of account balance and income production. Generally speaking, negative returns in the early years of your retirement can potentially reduce how long your assets can be expected to last.
American writer H.L. Mencken once remarked that, “For every complex problem there is an answer that is clear, simple, and wrong. “ 3
Anticipating a lifetime of withdrawals from a defined asset pool over an indefinite period of time is a complex challenge for which there is no simple solution. Pursuing this challenge can require creative approaches and persistent vigilance.
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Dollar-cost averaging does not protect against a loss in a declining market or guarantee a profit in a rising market. Dollar-cost averaging is the process of investing a fixed amount of money in an investment vehicle at regular intervals, usually monthly, for an extended period of time regardless of price. Investors should evaluate their financial ability to continue making purchases through periods of declining and rising prices. The return and principal value of stock prices will fluctuate as market conditions change. Shares, when sold, may be worth more or less than their original cost.
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This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.
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BrainyQuote, June 2017
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