In this series, we are exploring the financial risks retirees must navigate. In Part 1, we explored bear markets and the sequence of returns risk.
Predicting your first 5-7 years of retirement is impossible, especially with investment markets. Planning to retire at the perfect moment is naïve, considering all the black-swan (unpredictable) events that we have no control over.
Timing of Retirement
Let’s start with an example that shows an astounding disparity between three hypothetical individuals who retired at different times.
Three people retired in 1969, one in January, another in April, and the last in July. How did their nest eggs fare over the next 30+ years? (These retirees faced a decade of high inflation, which echoes our recent struggles with inflation.)
One retiree runs out of money, one maintains, and one has a portfolio that grows. Keeping all else equal, like distributions and inflation rates, the only difference is the time when they retired. Even three months can make a huge difference.
The Power of Losses
Losses can be more powerful than gains. It takes a larger return to recover from a loss. For example, a 10% loss needs an 11% gain to recover. A 25% loss requires a 33% gain. And a 50% loss needs a 100% return to get back to even.
This problem is exacerbated when adding distributions to the mix, which is the case for retirees. A 20% loss without a distribution (meaning you are not taking out any money) needs 25% to recover. With a 4% annual distribution, at least a 56% return is needed to get back to even. A 5% distribution rate requires a 67% return.
Many retirees do not have a choice when taking out money because the IRS mandates a required minimum distribution at a certain age. This usually equates to about 4% of tax-deferred assets.
Inflation
Many people call inflation the “silent killer” because it is not the first thing we think of as a risk to lifestyle. Over the long run, though, this can ruin a retirement plan.
Inflation has been included in all our examples thus far and should be a part of every financial plan. Inflation is a rise in the cost of living every year.
If inflation is at 2-3% and you earn 7-8% annually in your portfolio, you are keeping up. The difference is a real gain. However, if inflation gets up to 7%, 8%, or 9%, like we saw last year, it is hard to keep up. You will likely burn through your money faster and risk running out of money too soon.
Knowing that we depend on that income in retirement can be a little scary. We prefer that it grow and sustain us throughout retirement. Crucial measures need to be taken in a well-drawn-out plan. That is exactly what we do here at Smedley Financial, and we’d be happy to sit down and explain the nuts and bolts to you in person.
Tune in for Part 3 in the newsletter.
Listen to a discussion on the Power Up Wealth podcast regarding retirees’ concerns.
