By Josh Katzowitz, WCI Content Director
One of the scariest unknowns for those about to retire or for those who are seriously thinking about doing so is the sequence of returns risk. Intertwined with the 4% guideline, which gives a back-of-the-napkin approach for how much you should withdraw from your portfolio annually so you don’t run out of money in retirement, the sequence of returns risk (SORR) says that you’re at a higher risk if the market performs poorly at the beginning of your retirement.
If you retired between 2020-22, SORR is a real danger to you. Inflation rose to more than 9% in 2022, stocks tanked, and even bonds (supposedly the safety net for retirees) fell. If you’ve retired recently . . . yikes.
But the stock market has shown gains so far in 2023, inflation has fallen (it’s in the 5% and 6% neighborhood currently), and bond yields have risen. Is now, as we sit here in April 2023, a better time to retire when it comes to SORR? I asked Christine Benz, the director of personal finance at Morningstar and a keynote speaker at WCICON23, to give me her thoughts.
Is now a better time to retire than it was in 2022? Or if you’re thinking about retiring in 2024, are you in a better spot than you would have been in, say, January 2021?
“It’s definitely better,” Benz told me after giving her WCICON23 presentation on Sustainable Withdrawal Rates: A Deep Dive (which you can watch in full with the newly released White Coat Investor course Continuing Financial Education 2023). “Starting conditions are so much better now than they were a year ago or they were in 2021. It’s not terrible [to retire now].”
What Is a Safe Withdrawal Rate Right Now?
In research conducted by Morningstar, analysts concluded that if you retired in 2021 with a 50/50 stock-to-bond allocation, you could safely withdraw 3.3% annually (“It’s not terrible; it’s not great,” Benz said. “It’s below that 4%”). If you retired today, though, that safe withdrawal rate increases to 3.8%. That means, while factoring in 3% inflation, you could withdraw $38,000 on a $1 million portfolio in year 1. In year 2, you could take out $39,140.
But . . .
“The problem is that people’s portfolios have shrunk,” Benz said. “They don’t care about the percentage. They care about the dollar amount. If we’re telling them they can take a higher dollar amount from a smaller portfolio, that’s cold comfort.”
As Benz discussed during her keynote address at WCICON, she believes that determining what to withdraw in retirement is the hardest problem in all of financial planning, because you’re having to plan for so many unknowable (like what inflation is going to be and how long you're going to live and how the stock market is going to perform). And if the market conditions at the beginning of your retirement are poor, there’s more risk and probably more heartburn.
Those who retired in the late 1940s had a strong equity market, so their safe withdrawal rate could be much larger than 4%, especially with a portfolio heavy in equities. If you retired in the late 1960s, things got bad quickly with a struggling equity market in the 1970s and then with huge inflation numbers in the late ‘70s and early ‘80s. Benz said that’s the worst-case scenario for a new retiree.
If somebody retired in those bad market conditions in the early ‘70s with a 50-50 portfolio and a 5% withdrawal rate, they’d be out of money in 20 years. But if somebody retired with the strong market conditions in the 1980s and early ‘90s—essentially a reverse of the SORR—with the same portfolio and withdrawal rate, they would have actually grown their portfolio for the next 20 years.
“We hear about the 4% guidelines, and it’s based on the worst-case scenarios,” she said during her presentation. “But in other market environments, you could have taken way more than 4% and done all right. The problem is you don’t know in advance.”
Here's one slide Benz used during her presentation.
More information here:
How to Spend Your Nest Egg — Probability vs. Safety First
What If You’re About to Retire?
Say you want to retire now. As Benz mentioned, you’re probably in a better spot than those who retired from 2020-22, because the accumulation of the pandemic, the supply-chain shortages, and the tremendously high inflation took a big bite out of people’s portfolios.
But if you’re pondering retirement now or if you’re considering sticking in the workforce for just one more year, Benz said here’s what to think about: What are stock market prices like (lower is better than higher)? What are bond yields like (higher is better and should be safer)? And what are your inflation expectations (this one is hard to predict)?
While 2022 certainly felt like a bad year for most investors, Benz said it sets up those who are retiring in 2023 with better conditions than if they had retired in 2019-2021. That's when equity markets were expensive and high inflation was around the corner. With stocks and bonds down at the same time in 2022, a brand new retiree right now is in a better spot than those who hung up their work boots in the three years prior.
High inflation, though, could remain an issue.
“Inflation is a real negative from a sequencing standpoint,” Benz said. “Even though we may see the inflation rate taper off, we probably will see prices build on today’s higher levels. We’re not going to go back to pre-pandemic pricing on stuff. That’s not the way things work. The problem for retirement planning is if that inflation occurs early in your retirement, you are building on those higher prices throughout your retirement years.”
Since future inflation is unknowable and uncontrollable, it’s best to focus on what you can control. According to Benz, that’s making sure you have bond exposure in your portfolio, being thoughtful about non-portfolio sources of income that could ideally supply you with flexibility around your basic cash flow needs, and having the ability to adjust your withdrawal rate based on market conditions.
And what happens if you retired in 2021 and have already been affected by SORR?
“When we think of sequence of return risk, we think of it being stretched out a little longer than a year,” Benz told me. “This could be one and done. If you are in that position where you just retired recently and you’re trying to put yourself in the best position, can you reign in withdrawals? Ideally, you want your portfolio to repair itself a little bit. That’s the killer from a sequencing risk standpoint. You’re simultaneously over-withdrawing from a portfolio that’s dwindled. If you can reign in withdrawals, that’s probably the key thing. You have to embrace balance from an investment standpoint. That makes a lot of sense to me.”
Want even more of Christine Benz’s wisdom? Watch her entire keynote talk (and other amazing presentations that equate to more than 55 hours of content) with the newly released CFE 2023 course!
Money Song of the Week
Looking for a good way to make some passive income? How would you feel about earning $5,000 a day for something you created 40 years ago? That is the position in which Sting (aka Gordon Sumner) finds himself. Diddy recently revealed he pays Sting $5,000 in royalties per day because he sampled The Police’s 1983 smash hit “Every Breath You Take” on his own 1997 hit “I’ll Be Missing You.” That calculates to Sting earning an extra $45 million or so without having to play a single bass note or jot down one line of lyrics.
A few years back, Sting said he received $2,000 per day because Diddy took that sample without asking for permission. Diddy responded with this.
Nope. 5K a day. Love to my brother @OfficialSting! 😎 ✊🏿🫶🏿 https://t.co/sHdjd0UZEy
— LOVE (@Diddy) April 5, 2023
Said Sting at the time, via CNBC: “I put a couple of my kids through college with the proceeds.”
(He also probably could have put them through medical school, as well).
Anyway, let’s celebrate Sting’s windfall with a live performance of “Message in a Bottle.” The message of this particular tune doesn’t relate to money, but I just love Stewart Copeland’s drumming performance in a live setting and the way he changed grips during the song.
Tweet of the Week
Something to think about when you’re building a real estate investing empire.
👇 This is 110% true … you worry about tiny details in the first investment house that you never think about when you're 10x bigger.
Three reasons why — (1) more margin for error (logistics); (2) more confidence (emotions); (3) you've learned to think bigger (mindset). https://t.co/ojfAoefQIn
— Paula Pant (@AffordAnything) March 8, 2023
Are you thinking about retiring? Does SORR worry you? What else can you take away from Benz's advice? Comment below!
[Editor's Note: For comments, complaints, suggestions, or plaudits, email Josh Katzowitz at [email protected]]
I retired at the end of 2020 and took the whole of 2021 off.
Best Year Ever!
In 2022 I began doing casual teaching, supplementing my income by 20K or so a year.
I thought it made sense to leave the portfolio to burble along by itself when the market was rocky, while I tapped my cash bucket and earned a little extra for trips overseas etc.
When the market decides to behave itself, I’ll stop teaching again. 🙂
When you initially retired, were you planning to do that casual teaching? Or did you feel like the way market performed kind of forced you back into making some extra cash?
awesome post man I love how you are reporting back advice from Christine Benz, who definitely is the best looking which is the optimal withdrawal strategy and asset allocation when it comes to a successful retirement. it seems that there are many roads to dublin when it comes to mitigating SORR and also reinforces that same old adage, personal finance is personal.
I myself was going to start derisking from a 100% equity portfolio 5 years before retirement and add bonds/cash gradually until I get to a 60/40 portfolio at age 65, retire, and then if there is a bear market sell only bonds and if bonds are also down like 2022, I will have some of that 40% will include 2 years of cash so I’m not selling bonds down either. Likely also just have short term treasuries along with the 2 years cash. I’m really going to keep my risk of the equity side 🙂
Nice post. I retired last June and am finishing up my first year. I’m somewhat surprised with how little I’ve spent without depriving myself. I also fell into a seasonal part-time job that pays well and has reduced spending from the stash. Aside from that, all the preparation for retirement and developing an understanding of what could happen involving SORR has helped me deal with it all much more logically.
Side note involving Sting– he’s told his six children not to expect much in the form of an inheritance. Not because he doesn’t have the money, but because he wanted them to develop a strong work ethic and make it on their own. He’s quoted as saying “’I certainly don’t want to leave them trust funds that are albatrosses round their necks… They have to work. All my kids know that and they rarely ask me for anything, which I really respect and appreciate.”
Sounds like Sting read The Millionaire Next Door.
Christine is certainly both a good writer and knowledgeable about personal finance.
That said, to the extent that this is an accurate summary of her work, she has omitted some important information.
1. There have been many periods in the past where retirees were in a worse position two years into retirement. Those who retired in the year 2000 with a 60/40 portfolio and used the ‘4% rule’ to make withdrawals were down 33% from their inflation-adjusted starting balance by March of 2003. And it got MUCH worse. By February of 2009, they had lost just over 50% of their inflation-adjusted starting balance. But the market recovered, and now such retirees are in great shape to make it to the 30 year mark that the ‘4% rule’ was ‘designed’ for.
2. All the ‘ideal’ conditions for retiring seldom exist simultaneously. One of the few such periods in the U.S. where that happened was the mid- to late 1980s, where 30 year safe withdrawal rates turned out to be very high, almost 10% for some starting years.
3. Sequence of returns risk is ALWAYS present for both those who are retired AND those who are still accumulating.
4. Considering that inflation has been and continues to be one of the biggest risks facing retirees, it makes complete sense for all or at least most of an investor’s fixed income holdings to be in TIPS and I bonds. These completely remove the risk of unexpected inflation. And even though inflation is still historically high, the real yield on 5 year TIPS is still +1.35% (i.e., above whatever the inflation rate turns out to be). Retirees who will be in high tax brackets might be sacrificing some after-tax returns on TIPS compared to municipal bonds, but most retirees are in lower tax brackets than they were in while working, so this isn’t typically a big concern.
5. No matter what the conditions are when a retiree pulls the plug on working, minimizing their fixed expenses going into retirement is always a good strategy. Having all debt, even if at a low interest rate, paid off going into retirement reduces sequence of returns risk because it reduces the amount that the retiree must withdraw from the portfolio even when it is not doing well. Those who were high-income earners while working should be able to arrange their finances so that most of their retirement spending is discretionary, meaning that it could be fairly easily reduced if the portfolio is performing poorly.
3. Fair point, but I think it matters most and is highest right around the time of retirement.
4. I thought I was a big fan of TIPS at 50/50.
3. Yes, sequence of returns risk is a bigger problem in the years leading up and immediately following retirement, but it’s an issue for anyone making contributions to or withdrawals from their portfolio.
4. I wasn’t aware of your position regarding TIPS. Do you recommend 50% TIPs and 50% munis for high-income earners?
I am 50% TIPS, 50% nominal. Whether to use munis or not comes down to whether your bonds are in taxable or not. Given my portfolio is mostly taxable, most of my bonds are in taxable and thus most of my nominal bonds are in a Vanguard muni bond fund.
Many physicians, and especially those in academic medicine, have the majority of their retirement savings in tax-deferred accounts, from which the IRS requires withdrawal at a minimum rate, determined not by need or spending wishes, but only by age. In a time of market volatility, such as we are currently experiencing, it makes great sense to take the required minimum distribution from fixed-investments, while deferring withdrawal from equities until the market returns to a higher level. This preserves share numbers in the stock account(s), thus enabling larger future gains.
What? There’s no cost to rebalance in a tax protected account so no need to withdraw from any particular asset class in those accounts. All you’re doing is opting for a more aggressive asset allocation by withdrawing from fixed assets in a down market. Now that may or may not be a great strategy, but RMDs don’t have anything to do with it. All an RMD requires is for you to move your investment from a tax protected account to a fully taxable one. You don’t have to sell it. You don’t have to spend it.