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The Biggest Risk to Retirees Revisited

"The most important part of a plan is planning on your plan not going according to plan." - Morgan Housel, author & investor

The last decade was blissful by most investor standards.

Healthy returns.

Few negative years.

Paltry volatility.

Low interest rates.

Steady inflation.

Home prices going up.

It added up to a brisk tailwind at the back for retirees (see our December 11th, 2019 post, "Did Investors Experience a Golden Decade?"

Many retirees were able to comfortably live off their investment portfolios and see their account balances grow.

Not too shabby.

2022 has been the opposite.

Ugly returns.

Almost every asset class is down.

Elevated volatility.

Rising interest rates.

Higher inflation.

Home prices are coming back down to Earth.

Despite the headwinds, I've noticed a disturbing trend...

Retirees still spending like it's 2010 - 2021.

We outlined the perils of sequence of return risk coupled with outsized portfolio distributions in our post, "The Biggest Risk to New Retirees."

It's playing out in real-time. Let's use an example (we assume distributions and investment gains are credited at the end of year for simplicity)...

Rupert & Agnus retired in 2010. They have $1,000,000 in a retirement portfolio.

They plan to spend $100,000 per year (10% distribution rate) out of their retirement funds.

Year 1: Starting portfolio balance $1,000,000

Rupert & Agnus' portfolio achieves a 7% return or +$70,000.

At the end of year 1, the portfolio balance is $970,000 ($1,000,000 + $70,000 investment gain - $100,000 distribution).

Year 2: Starting portfolio balance $970,000

Rupert & Agnus' portfolio achieves a 10% return or +$97,000.

Despite taking out $100,000, their year-end portfolio balance is relatively unchanged @ $967,000 ($970,000 + $97,000 investment gain - $100,000 distribution).

Year 3: Starting portfolio balance $967,000

Rupert & Agnus' suffer an 18% loss in their portfolio.

Coupled with their $100,000 distribution, the new portfolio value is $692,940 ($967,000 - $174,060 investment loss - $100,000 distribution).

Year 4: Starting portfolio balance $692,940

Rupert & Agnus' suffer a modest decline of 5% in their portfolio.

Including the distribution, the new portfolio value is $558,293 ($692,940 - 34,647 investment loss - $100,000 distribution)

Ending portfolio value $558,293

In four years, Rupert & Agnus have cut their investable asset base almost in half. The large impairment makes it unlikely they will recover to the original portfolio value.

The depleted portfolio value is unlikely to support their high level of spending. Rupert & Agnus are at risk of running out of money.

Rupert & Agnus' spending plans were emboldened by a long period of stock market gains.

Bull markets can cover all sorts of unsightly warts.

Poorly invested? Who cares, market goes up.

Not sure how much you're paying in fees? Who cares, market goes up.

Haven't a clue about the risks you are taking? Who cares, market goes up.

Spending without a care in the world? Who cares, market goes up.

"Only when the tide goes out do you discover who's been swimming naked." - Warren Buffett

Some recent retirees have built their lifestyle around the premise that markets only go up. That's their "new normal" and they have built their plan accordingly.

Worst yet, once accustomed to the bull market lifestyle, it's really hard to downshift.

The phenomenon is so common, personal finance gurus have coined the term "lifestyle creep."

Lifestyle creep happens when increased income (or portfolio values) leads to increased discretionary spending. Once a person gets used to their higher-cost lifestyle, it's really difficult to cut back.

Here's how you can mitigate sequence of return risk and make sure your retirement is on the right track...

  • Rerun your financial plan using lower portfolio values. Most portfolios are down in 2022, run the numbers again to see if you're still on the right path.

  • Revisit the budget and cut spending where you can. You probably did something similar during your working career. Was your company laying off workers? Was revenue down? You probably didn't carry on like nothing was wrong and spend freely.

  • Stress test your financial plan. Assume a prolonged period of lower future returns. Run back-to-back periods of deep market losses. Crank up your expenses by 40%. If your plan is still favorable, you have a margin of safety.

  • Clean up the things you can control. We often talk to potential clients who obsess about every ebb & flow in the stock market. Meanwhile, they are paying 2.5% to a broker, own mutual funds that saddle them with heavy tax bills, and have no clue how much risk they are taking. Clean up your financial household. We call it, "taking the low-hanging fruit."

For more reading on sustainable portfolio distributions rates, see "Is the 4% Rule Dead?"

If you want to create a margin of retirement safety, reach out to Pure Portfolios at or click here.

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