Christine Benz: Hi, I'm Christine Benz from Morningstar. Is a volatile market a disaster if it occurs early on in your retirement? Joining me to discuss that topic is Judith Ward. She is a senior financial planner for T. Rowe Price.
Judith, thank you so much for being here.
Judith Ward: I appreciate it. Thanks for having me.
Benz: So, let's talk about this phenomenon that retirement researchers call sequencing risk, the risk that in the years right after my retirement, the market drops a whole bunch. This is top of mind for today's retirees. Let's talk about why that can be so problematic, that sort of luck of the draw really about how the market performs.
Ward: Yeah, I think it can be problematic, because when you first enter into retirement, a lot of times you might be in retirement for decades, right? So that nest egg needs to last for maybe 20, 30 years, if not longer. And early in retirement, if the market goes down significantly, and you're drawing from your portfolio, then you've actually locked in these losses. So, the money you've withdrawn is never going to have the chance to recover. So, you're already taking money out of a portfolio balance that's depleted. And so, it could really kind of hurt this idea of your longevity throughout retirement and your money lasting.
Benz: So, you and the team at T. Rowe Price did some research on looking back at past downturns to see how a retiree would have done with a balanced portfolio employing the 4% guideline, so that 4% withdrawal initially with inflation adjustments on that dollar amount thereafter. Let's start with the early 70s period. This is, I think, where the 4% guideline actually originated, or that was the period that Bill Bengen looked at when determining, what is the most you could have taken out without running out of money. What was going on in the early 70s? Bad stock market environment?
Ward: Yeah, bad stock market environment, high inflation, which we haven't seen in recent memory, actually. But high inflation, bad stock market. And boy, I think the markets were down, I don't know, 30%, 40%, maybe more. But we did look at a balanced portfolio, because at T. Rowe Price, we think that that's the kind of portfolio someone at retirement should have. And we wanted to test the 4% rule to see, did it actually work. And we wanted to look at a 30-year, a full 30-year period, historical period. Of course, we also looked at more recent periods, but it hasn't been a full 30 years.
Benz: So, like the 2000s as starting point.
Ward: 2000, 2008, yeah, but it hasn't been a full 30 years.
Ward: So at first we wanted to look at a full 30 years where if someone retired in like 1973, what would have happened over those 30 years with just a consistent 60-40 portfolio? And we found that if they had started with the 4% of their balance and increased that amount based on the actual inflation at the time, they would have been fine by the end of 30 years.
Benz: So, even though it was high inflation?
Ward: Right, even though it was high inflation. However, a few years into retirement their portfolio would have dropped, I think, like 30%. So, imagine being in retirement for only three years, and seeing your portfolio drop--I think we started with a $500,000 portfolio--seeing it drop to under $300,000. I mean, that's pretty scary.
Ward: And you're thinking, how is this going to last me for another two decades? And so, the assumption we made was, well, what if, at that point, because we know retirees adjust, they adjust their spending, what if they kept their spending flat? And how long would they have to keep their spending flat until their portfolio came back up, not to the entire $500,000, but came up to something that maybe they would be a little more comfortable. And we found that if they kept their spending flat for just a couple of years, they would have come out OK. And then, even later in retirement when the stock market took off, I mean, they actually could have spent a whole lot more money later in retirement and been fine. I mean, actually, it ended up that they had a lot of money at the end of that 30-year period because of the rebound. But just taking some, I think, smaller adjustments early on could really, I think, help to weather that early period of retirement.
Benz: So, in this case, a step that was actually pretty impactful was simply flatlining spending, not taking any sort of an inflation adjustment in the years in which the portfolio is depressed?
Ward: Correct. And even though we talk about flatlining or keeping spending steady, because inflation was high during that time, it probably did really mean a spending cut.
Ward: Because they would have had to cut something to keep it flat. But they didn't have to make huge adjustments. And the other thing they didn't have to do was panic, and move their portfolio to cash, which would have really been detrimental for the rest of their retirement. So, just by taking these small adjustments--and we talk about as people head into retirement, I think it's really important to look at how you're truly going to spend your money. So, if you do need to make adjustments, you know where you might do that. I think that's a really important step prior to retirement. So, if something like that does happen, you know where you might take a little bit of a haircut in terms of spending, but just for a short time period. This ended up just two years that you had to kind of go through that.
Benz: So, the '73, '74 cohort of retirees, they were okay using the 4% guideline, maybe modified a little bit. The 2000s retirees retiring into that dot-com bust, they're also doing OK. But they're only 19 years in, so we don't truly know.
Benz: I guess the issue, though, is that past is not prologue, right, that the environments that prevailed in these two periods may not be the type of environment that we encounter going forward. So, let's talk about how retirees can take control of the next down market that materializes. So, maybe I am that early retiree--or the retiree who just started and I happen to hit this Armageddon of a market environment, what steps can I take to preserve my plan? It sounds like maybe being willing to be a little bit flexible about my spending. What else?
Ward: Yeah, and we think that, during times of market volatility, it's important to focus on the things you can control. And one of the things you can control is your asset allocation. Now, maybe there's people that have just enjoyed this run-up, you know, this bull market, and they've just let their portfolio run. So, they might be overemphasizing stocks. Now would be a good time before it hits to just think about your asset allocation. When we look at different asset allocations, we looked at an 80-20 stock portfolio, a 100% stock portfolio, and these were just broad indices to represent the portfolios, and how they did in 2008. And so, an 80% to 100% stock portfolio was down like 30% to 40%.
So, you have to ask yourself, if that were to happen--and that's probably a worst-case scenario--but if that were to happen when I'm in retirement, or at any point, would that impact my lifestyle? Would that truly impact my lifestyle? And if the answer is yes, then you probably want to de-risk a little bit or get into that more of a balanced type of portfolio, so you're not experiencing that degree of a short-term loss, especially when you might be taking money out of your portfolio. So, that's something you can control, is your asset allocation.
Another thing you can control is your spending. And that's where I just talked about, knowing what you're going to be--being able to adjust your spending. Another thing you might want to consider is this idea of a cash contingency, starting to build up some money on the side. Again, we looked at these portfolios and how they recovered. And in the Great Recession, a stock portfolio took almost five years to recover, a 60-40 portfolio recovered in two years. So, maybe you have up to two years of your spending need in this cash contingency or this sleep-at-night money, so that it's an alternative to draw from if you feel like you really don't want to touch your portfolio at some point in time over the short time period.
Benz: Judy, always great advice. Thank you so much for being here.
Ward: Thank you.
Benz: Thanks for watching. I'm Christine Benz from Morningstar.