Retiring in a downturn

(NYTIMES) - Most people finance their retirement with a certain amount of faith: Investing will help their savings keep pace with inflation, institutions will continue to work as they always have, it will all work out in the end.

It's challenging to maintain that optimism in moments like these, when it seems just about everything is at stake and nothing is certain. Of course the future has always been uncertain.

"This year has been unnerving for retirees because it has been a triple whammy - falling stock prices, falling bond prices and high inflation," said Ms Christine Benz, director of personal finance and retirement planning at Morningstar.

Unlike younger workers, retirees can't afford to wait it out.

T. Rowe Price recently peered into the past half-century to see how people who retired into different downturns fared, even in periods of high inflation. The good news: Their portfolios performed well, or are expected to. The less good: Past performance is no guarantee of future results.

The firm's research is rooted in the widely known 4 per cent rule of thumb, which found that retirees who withdrew 4 per cent of their retirement portfolio balance in the first year, and then adjusted that dollar amount for inflation each year thereafter, created a pay cheque that lasted 30 years.

Using that framework, T. Rowe Price analysed how investors with a US$500,000 (S$694,000) portfolio - 60 per cent stocks and 40 per cent bonds - would fare over 30 years had they retired at the beginning of the year in 1973, 2000 and 2008.

They would all start withdrawing US$1,667 monthly - or US$20,000 annually - and then increase that amount each year by the previous year's actual inflation rate.

Let's rewind to 1973, which, given the oil embargo and high inflation rates, echoes the present. Retirees then would have had to watch their portfolios shrink to US$328,000, or nearly 35 per cent, by September 1974, and inflation rise by more than 12 per cent by the end of the same year, the analysis found. An incredibly painful one-two punch.

The retirees had no idea then that circumstances would turn around, but within a decade into retirement, the portfolio balance had reached US$500,000 again. And even after 2000's downturn, at the end of 30 years, the portfolio had soared to well over US$1 million.

Ms Judith Ward, a senior financial planner and thought leadership director at T. Rowe Price, conceded that retirees don't actually spend in straight lines, and that they tend to spend more earlier in retirement. But the study, she said, underscores the importance of starting with a conservative spending plan when a portfolio is down.

"That lever of how much you are spending is really a strong lever that works," she added.

Using the same approach with those who retired into more recent bear markets - in the periods after 2000 and 2008, when the stock market lost roughly half its value - the portfolios were also projected to be sustainable, even though retirees still have roughly eight and 14 years to go before they hit 30 years of retirement.

Other experts caution against taking too much comfort in past results because the future might have something else in store.

"Using the past provides false confidence," said Mr David Blanchett, head of retirement research at PGIM, the asset management firm part of Prudential Financial. That's why financial experts suggest taking a flexible approach to withdrawals, focusing on what you can control in that moment as conditions change. Here are some strategies that may help.

One approach is to think about your withdrawals in terms of needs, wants and wishes.

Maybe the withdrawal rate to cover your basics is 3 to 4 per cent, but your wants might be somewhere from 4 to 6 per cent.

"The most important thing is to have your needs covered," Mr Blanchett said.

The big idea here is to keep at least a year's worth of basic expenses in cash or its equivalent, so retirees experiencing a downturn can spend out of this bucket instead of having to touch their portfolio, giving it more time to recover.

This approach requires some planning, but it can ease anxiety for retirees. Critics have said keeping a meaningful amount of a portfolio in cash may pose a drag, hurting returns over the long run, but for many retirees it may provide a plan they can stick with - and that's the most important factor.

This strategy, created by financial planner Jonathan Guyton and computer scientist William Klinger, encourages retirees to be flexible, increasing their withdrawals when the market is doing well and pulling back when it is not.

Their research found that retirees are usually safe starting out with a withdrawal rate of roughly 5 per cent for the first year, as long as they cut back when they receive a warning signal. That warning light starts blinking when the withdrawal rate increases a certain amount - or one-fifth - above its initial rate. So if the portfolio plummets and the amount withdrawn now translates into 6 per cent or more, retirees would need to cut their withdrawal dollar amount by 10 per cent.

For example, consider a retiree who in the first year collects 5 per cent, or US$25,000, from a US$500,000 portfolio. If inflation was 9 per cent, the next year's withdrawal would normally rise to US$27,250. But if a guardrail was tripped - that is, if the portfolio plunged to roughly US$415,000, making that US$25,000 equivalent to a 6 per cent withdrawal rate - the sum withdrawn would instead need to decline to US$24,525 (or 10 per cent less than US$27,250).

This is another rough rule of thumb that helps retirees figure out whether they may be withdrawing too much. Let's say you're retiring at 70 and you decide you will probably need your money to last until age 95.

That translates into a 4 per cent withdrawal rate for that year. With a US$500,000 portfolio, that's US$20,000.

But if you're on track to pull out US$30,000 that year - or 6 per cent - you may want to pull back. "It's an ongoing gut check," Mr Blanchett said. "Is this going to work long term? And that is a really simple way to get an answer."