Bear Market Withdrawal Strategies for Retirees

If your are retired and taking withdrawals from your investments, you’re likely very concerned when the market isn’t doing well. That’s when bear market withdrawal strategies become important. Even if you are not taking distributions out of your account, it’s important to know what to do when that bear market hits.

The amount of money you need to retire doesn’t decline when the market does. What’s the best way to generate income during retirement in these kinds of conditions?

One of my favorite clients in Arizona sent me an article that speaks to this very point. Mark Miller wrote a piece recently for Reuters called “Lessons for Retirees from the Bear Market Decade.” In it, the writer shares a study done by T. Rowe Price. This study searches for the best thing for retirees to do with their withdrawals during bear markets.

The objective was to make sure the retiree had the best chance of having an income until at least age 95. In order to make the study really valuable, they looked at the last decade, a very tough one indeed for investors.

The study concluded that, while the last decade was very tough on new retirees, they could really boost the odds of not running out of money by reducing the amount they withdrew from the account for the first few years after a bear market.

This may seem like common sense to you, but in practice this is usually the last thing people do. Folks dislike income reductions and of course I can understand it. But the way I look at it, if it’s a choice between a small and limited reduction now or a big and permanent reduction later, I’ll take the pain now.

Remember, if there is ever a time to think long-term, it’s when you’re retired. If you retire at age 65, you may very well have another 25 or 30 years to live for either yourself of your spouse. You have to be strategic and mindful about your choices.

Your retirement security rests on a three-legged stool: your income, your assets and your spending. If one of the three legs changes shape, you’ll be sitting on a wobbly stool if you don’t adjust the other two legs. Make sense?

Let’s take a closer look at what the folks over at T. Rowe Price did.

First, they looked at one of the roughest decades ever for investors: the years between 2000 and 2010. Don’t forget, you had two bear markets during that time. One bear market happened in 2002 and another occurred in 2008. Let’s say you retired on January 1 of 2000 with $500,000. The study assumes you invested 55% in stocks and 45% in bonds.

They studied the outcome of four withdrawal strategies:

1. Withdrew 4% of the account value the day you retired and increased your withdrawal each year by 3% to match inflation.

2. Cut the withdrawal rate by 25% for three years from the bottom of the market.

3. Cut out just the COLA adjustments for three years after the bottom of the market.

4. Quit stocks for good. The study considered what happened to people if they pulled all their money out of the market at the end of the 2002 bear market and never got back in. Instead, the investor moved into a bond portfolio and stayed put.

The study looked at the actual returns during the last decade and then used a random simulator (called the Monte Carlo method) to approximate what the returns might be, year by year, through 2030. They then looked at the results for the 30-year period 2000 – 2030.

The results:

The person who cut back 25% of their withdrawals for three years starting at the end of the bear market had the best chances of success. That means she had the least likelihood of running out of money.

Who had the worst odds? The person who ignored the situation and continued taking withdrawals as planned.

What I like about this study:

First, it proves that you are better off by adjusting your withdrawal rates based on your account value. The person who did this has a 43% chance of success according to the study. The person who ignores the market and continues withdrawals as planned has a 94% chance of going broke.

It also proves that reacting to the market, bailing out of the market and diving into bonds in order to satisfy the emotional need for security is suicide. These people had a 100% of going broke over the 30-year period examined.

The flaws of this study:

While I think the study does an excellent job of driving home the point, it’s unclear on a few items.

First, it doesn’t illustrate what happens if you just continue taking 4% of the value of the account and readjusting each year. Let’s look at our example above. Rather than cut 25% of your income, why not just take 4% of the value of the account – 4% of $86,000? I like this approach better because it’s self-regulating, easy to calculate and successful in my experience.

Also, the “winning strategy” still leaves investors with only a 43% chance of NOT running out of money. That means they still go broke 57% of the time. Not OK. This is another reason why I like the 4% readjusted withdraw rate and it’s what I generally use with my clients. It’s also one of the main reasons I don’t like buy-and-hold investing. The risks can be too great.

Of course, it’s not so easy to slash your withdrawals when you are retired. I understand that. But given the choice between almost certain brokehood (a new and exciting word I just made up) and financial peace of mind, I know what choice to make. How about you?