Avoiding the ‘Double Whammy’ of Portfolio Withdrawals in Weak Markets
Angela T. from Kenosha, WI asks: Hi Mitch, I’m retiring at the end of the year and plan on withdrawing $2,000/month from my Rollover IRA. I’m worried that just as I start making withdrawals, the market is finally going to start going down (just my luck). Do you have advice on how to navigate this issue?
Thanks for writing, Angela. You ask an important question, and there is a financial term for what you’re referring to, called “sequence of returns” risk. This risk is basically defined by what happens when sizable portfolio withdrawals collide with weak market returns. If money is coming out of a portfolio while it’s also declining in value, the result can be a ‘double whammy’ downside impact on your net worth.
Let me give you and readers an example of how this risk can play out.
Say, for instance, that a retiree on January 1, 2000, had $1 million invested in the S&P 500, and they planned to withdraw $40,000 every year plus 2% extra each year for inflation. Because of the long bear market experienced in 2000 – 2002, the 2008 Financial Crisis, and the Covid-19 bear, the remaining balance at the end of 2020 would have been $470,000. It’s not necessarily that the portfolio endured three bear markets – it’s that the first bear happened right away.1
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That’s because sequence of returns risk played an outsized role in this portfolio being worth less than half of where it started 20 years prior. Because the S&P 500 lost -37% over the first three years, and the retiree was withdrawing $40,000 each year, the portfolio was simply unable to recover even though the market bounced back every time.
Fortunately for retirees or soon-to-be retirees, there are a few things you can do to navigate sequence of returns risk. The first would be to set aside a year or more’s worth of income in cash. Doing so means taking your monthly or annual withdrawals for living expenses while your portfolio remains invested according to your needs and longer-term goals. In other words, you do not need to be selling positions to raise cash potentially during a market downturn.
Another option is to try and limit spending during a market downturn and/or during recessions. If your budgeting allows, it could be wise to spend less during challenging market environments and make it up later once the market and the portfolio recovers. Being able to control your spending based on market conditions is a key factor in managing sequence of returns risk.
In the current environment, given your situation of retiring at the end of the year, I do not see an issue with raising a year or two’s worth of cash now to provide for your income needs, which will allow you to leave your portfolio alone (i.e., invested according to your long-term goals and needs) as the market cycle enters its next phases. These are the types of decisions we at Zacks Investment Management can help you weigh, by running cash flow analyses and testing different options and outcomes. If you’d like this type of analysis and help, please do not hesitate to reach out.
I would also like to share some additional steps you can take to help protect your investments and create a portfolio that meets your financial goals. To help you do this, I recommend reading our guide, 7 Secrets to Building the Ultimate DIY Retirement Portfolio.3
If you have $500,000 or more to invest, get this guide to learn our ideas on the step-by-step process of building and maintaining a retirement portfolio that will potentially help you reach your goals and enjoy a secure retirement.
2 ZIM may amend or rescind the guide “How to Build Your Ultimate Retirement Portfolio” for any reason and at ZIM’s discretion.
3 ZIM may amend or rescind the guide “How to Build Your Ultimate Retirement Portfolio” for any reason and at ZIM’s discretion.
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