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:
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.
— 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].]