How Your Portfolio Accumulation and Withdrawal Years Are Different

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The last 10 years of stock market returns have been pretty remarkable. If you invested $100,000 in the S&P 500 in the year 2000 and held it though the dot-com crash and financial crisis, you would be closing in on $300,000 today. However, if you retired in 2000 with a portfolio invested in the S&P 500 and used a 4% withdrawal rate (increasing each year by 3% for inflation), your nest egg would less than $50,000 and on a path to zero!

This stark difference between accumulation and withdrawal modes is illustrated by the chart above, taken from the Blackrock Blog post How to avoid “dollar cost ravaging” in retirement. “Dollar-cost ravaging” is also known as “sequence of return risk”, as explained in the this quote:

Investors have probably heard the term “dollar-cost-averaging,” where you make regularly timed investments to smooth out the risk of “buying high.” Retirees tend to do the opposite. Instead of putting money into their portfolio, they take it out with a regular cadence in the form of income. “Dollar-cost-ravaging” occurs when the market loses value while you’re taking withdrawals, especially in the early years of retirement. Because money is coming out rather than going in, it’s harder for the retiree to recover their losses when markets rebound. We even saw this during one of the most successful bull markets in our history over the past decade. The sequence of returns matters, and the biggest challenge is a bear market early in your retirement.

Unfortunately, there is no easy solution to this problem. This is what the article offers: “Striking the right balance to limit your losses in a declining market is just as important as capturing growth when the market is strong.” In other words, don’t hold too much in stocks, but also not too little. You can more easily weather a recession when you are still working and saving then when you are spending it down. I think more important advice is that you should be ready to withdraw less money out of your portfolio if the market tanks early on in your retirement withdrawal phase. Don’t follow a rigid withdrawal rule from some academic study into oblivion!

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  1. Francis Schommer says

    When you say:
    used a 4% withdrawal rate (increasing each year by 3% for inflation), your nest egg would less than $50,000 and on a path to zero!

    That’s wrong, you DON’T increase 3% per year to “adjust for inflation” because the inflation is factored in with the 4% withdrawal. (as in the growth includes inflation, so the 4% would be a greater number later).

    • It depends on your withdrawal strategy. A commonly-accepted one (and the one used in this chart) is that you withdraw 4% and increase a little bit each year to keep up with inflation. So a $1,000,000 portfolio would create $40,000 in Year 1 and then $41,2000 in Year 2, and so on. Most people find it difficult to control their expenses to match the stock market, for example to spend 20% less in Year 2 and then increase by 30% in Year 3, decrease by 10% in Year 4, etc. Rent, health care expenses, food, don’t fluctuate like that.

      I’m not saying this is the best strategy, just that it is a simple one that many studies and backtests are based upon.

      • Francis Schommer says

        We’re both talking about the trinity study, and if you take 4% of $1M in the first year ($40k), and the $1M becomes $1,100,000 during the year, the next year 4% will be $41k.

        You still are only withdrawing 4%.

        40k going to 41k is automatically adjusting for inflation

        • I’m not sure I follow. 4% of $1.1 million is $44,000 (not $41k). If you are taking 4% of the ongoing portfolio value, your withdrawal rate will vary wildly with the portfolio value. If the portfolio goes up 10%, then your withdrawal amount goes up 10%. You could do that, but that’s not what the Trinity study was about.

          For the Trinity study, the 4% only refers to the initial portfolio value (not ongoing). From the Wikipedia entry:

          The 4% refers to the portion of the portfolio withdrawn during the first year; it is assumed that the portion withdrawn in subsequent years will increase with the consumer price index (CPI) to keep pace with the cost of living.

          • Francis Schommer says

            Okay you’re right, I misread it.

            So it would potentially be 4% the first year, 4 + 3 = 7% the second year?

            Or would it be 4% the first year, which would be 40k, and then increase that 40k by 3% ($1200), and keep withdrawing an additional $1200 each year on top of the $40k?

            Is that what that chart shows?

  2. Interesting data! This sort of scenario always gives me pause when hearing FIRE stories/strategy – since FIRE became en vogue, every FIRE’d person did so on the back of a strong market.

    I think unless one is pursuing a leanFIRE or fatFIRE strategy, it is difficult to pull the trigger on the “RE” situation unless you have market-independent income of some sort – whether it be rental properties, Social Security, pension, something. Medical insurance is a whole other issue that there’s no good solution for in “RE” in the US unless you’re Medicare-eligible.

    The sort of strategy you’ve implemented, Jonathan, which permits part-time work is truly ideal.

  3. The fine print on the diagram says withdrawals increased “3% per year to keep up with inflation”, but actual inflation during this period was closer to 2+%. I wonder how the chart would be using the actual inflation vs a flat 3% per year. Also, the original use of the 4% rule by Bengen included 50% bonds, though there are several popular revisions that tweak that to 80/20 or add small cap or intl, etc. Blackrock/Morningstar does a disservice by sticking to the more extreme scenario (100% large cap stocks) to show its point especially since 100% stocks was NEVER the original 4% intent.

    • I think you make good points. This chart is exaggerated in those respects, I think mainly to show the sequence of returns effect.

      However, as the stock market keeps going up and bond yield keep going down, more and more people are increasing their stock exposure in retirement (and other things with higher yields like MLPs) and feeling comfortable with more stocks. Hopefully this gives them a pause.

  4. To me this reads as a positive for retirees. 4% withdraw with a 3% yearly raise. 20 years later through ups and downs still have 50% of their portfolio. I imagine most people are dead after 20 years of retirement. In this case they have another several years of runway still. Not bad

    • Look at the chart more closely. After 19 years (vs. 20) only have about 10% of original portfolio left. But, at least it hasn’t hit 0 yet after close to 20 years. And I agree a lot of folks are gone about 20 years into retirement if they retire at a “normal” age. And at that age can supplement with SS.

  5. I agree that taking 3% EACH year for inflation is misleading for this study. Curious when they indicate their withdrawals and investments, what date to they do this during each calendar year?

  6. This is a powerful if inexact indicator that not all years are made equal.
    The narrower your date-range, the more the chance of wildly different results from expectations.
    Over a period of several decades this smooths out.
    But to assume 2020-2040 will be same as 2000-2020 is a mistake no one should make.

    * past behavior not an indicator of future results

  7. This comparison is meaningless to me. I’d like to know if I retired in 2000 and put the money in other portfolio, not sp500. How much can I have now with the same withdrawal rate?

  8. Thanks for the chart. It’s just another reminder for me that when I approach retirement I best rebalance towards fixed income!

  9. Many retirees will use systematic withdrawals from an investment portfolio for retirement income. I’ve done new research into the best retirement withdrawal strategies. History shows that your success can vary widely using the same portfolio and the same overall withdrawal rate, without changing your investments or taking on more risk. It all depends on how you withdraw from different asset classes like stocks and bonds. The secret is keeping it simple and using a consistent, value-driven approach. The payoff could mean extracting millions more income from your nest egg over the course of a long retirement.

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