retirement savings  |  september 13, 2022

How to Make Your Savings Last When Retiring Into a Down Market

A conservative withdrawal approach is part of a sustainable retirement spending plan.

 

Key Insights

  • A severe market downturn at the onset and in retirement can cause concern for investors.

  • We analyzed three scenarios, starting with bear markets, to gain insight on portfolio sustainability.

  • An initial 4% withdrawal approach can help retirees extend the life of their portfolio even during inflationary environments.

Judith Ward, CFP®

Thought Leadership Director

Individuals nearing retirement—or just entering retirement—may be concerned about what a market downturn and higher inflationary environment may mean for their withdrawal strategy. They may also be thinking about the ability of their savings to support them throughout their retirement.

The sequence of returns (the order in which markets rise and fall) is important when it comes to your retirement withdrawal strategy. Market declines within the first five years of drawing down retirement assets can significantly impact the chance of the portfolio lasting, especially when planning for a retirement horizon that could span decades. To better understand the long-term impacts of this kind of early decline, we analyzed scenarios from three different time periods to gain insight on portfolio sustainability:

  • Retiring January 1, 1973, the most recent 30-year period that started with a bear market.

  • Retiring January 1, 2000, 22 years into retirement and already living through two bear markets.

  • Retiring January 1, 2008 on the of the great financial crisis and about halfway through a 30-year retirement.

Scenario 1: A 1973 Retirement Date

In 1973, the onset of the oil embargo and an energy crisis sparked a recession. The early 1970s was also one of the highest inflationary periods in history, as prices more than doubled in 10 years. Our analysis assumed a starting portfolio of $500,000 with an asset allocation of 60% stocks and 40% bonds throughout the entire horizon using the S&P 500 Index and the Bloomberg U.S. Aggregate Bond Index.1

We tested the “4% rule,” assuming the investor started with an initial withdrawal amount that was 4% of the starting portfolio balance ($20,000 the first year). This amount was adjusted each year based on actual inflation2 in order to maintain purchasing power over the 30-year spending horizon. Many experts consider the 4% rule a safe starting point to help investors navigate an uncertain market environment, especially at the onset of retirement.

The beginning monthly withdrawal for this investor was $1,667. But retirement would get off to a rocky start as they entered a bear market that would see the S&P 500 Index decline 48% within the next two years. (See Fig. 1.) Not only did the investor have to cope with watching their portfolio shrink to nearly $328,000 by September 1974, but inflation was also a significant factor. Inflation ended 1972 at 3.4% and soared to over 12% by the end of 1974.2 Money at that time didn’t go as far as it used to when it came to paying for everyday expenses like gas and food.

Recovery was around the corner, however, and the investor’s balance began to grow again with the help of two subsequent bull markets. The account balance recovered to over $500,000 about 10 years into retirement in December 1982 and reached $1 million by the end of 1995. Those gains helped the investor weather the significant bear market in March 2000. And at the end of 30 years, the portfolio balance in this scenario was well above $1 million despite all the market volatility during those decades.

(Fig. 1) Scenario 1: Retiring in 1973

A conservative withdrawal strategy may have helped a retiree weather a large market decline early in their 30-year retirement.

A conservative withdrawal strategy may have helped a retiree (retired in 1973) weather a large market decline early in their 30-year retirement.

Scenario 2: A 2000 Retirement Date

Now let’s consider a more recent case: an investor retiring in 2000 using the same assumptions from our first scenario, although there are only data to cover part of a 30-year retirement. Assuming the same starting balance and use of the 4% rule, this retiree would start withdrawing $1,667 per month in the first year of retirement and adjust each year based on actual inflation to maintain purchasing power.

In this scenario, the investor encounters the bear market that started in March 2000 as well as the great financial crisis of 2008. The S&P 500 lost 49% between March 2000 and October 2002 and just over 56% between October 2007 and March 2009. However, working in the investor’s favor during this period was a benign inflationary environment.

The portfolio in this scenario declines to nearly $300,000 in February 2009, but a subsequent period of strong market growth helps it rebound—in this case, to over $517,000 as of year-end 2021. (See Fig. 2.)

This rebound coupled with a conservative withdrawal approach has helped this investor prepare to weather this most recent market volatility as their portfolio balance dropped to about $508,000 by March 31, 2022. Although this investor is over two-thirds into a 30-year retirement horizon, they appear to be on a sustainable path so far. Using a Monte Carlo projection model to assess the next eight years of retirement,3 we find the portfolio will accommodate continued spending, resulting in a simulation success rate of more than 95%. That means out of the 1,000 market scenarios, the investor had at least $1 remaining in more than 950 of them.

(Fig. 2) Scenario 2: Retiring in 2000

Retirees in 2000 faced two massive market declines in the first 10 years of their retirement.

Retirees in 2000 faced two massive market declines in the first 10 years of their retirement.

What About a Higher Inflationary Environment?

The inflation assumption used in our projection is 3%. This assumption has been a bit higher than actual inflation in recent years; however, inflation in 2022 has increased dramatically, as high as 8% or more for many goods and services.4 Generally, inflation spikes abate eventually. Nonetheless, when we continued to inflate the withdrawal amounts for the remainder of the eight-year retirement horizon, we found a continued high simulation success rate, over 95%, when inflating spending amounts by 5%, 7%, and even 9%.

What if the Market Continues to Decline?

Applying one more stress test to the sustainability of the portfolio, we assume the balance drops by 20% to $406,688 and inflate the spending amount by 9% for the next 8 years, we find the simulation success rate does change to 93%—still well within an acceptable confidence zone generally defined as a simulation success rate of 80% and higher.

Scenario 3: A 2008 Retirement Date

Now let’s consider a most recent case: an investor retiring in 2008 using the same assumptions from our other scenarios. Today, this retiree would be about halfway through a 30-year retirement horizon. Assuming the same starting balance and use of the 4% rule, this retiree would start withdrawing $1,667 per month in the first year of retirement and adjust each year based on actual inflation to maintain purchasing power. In this scenario, the investor encounters the great financial crisis of 2008 when the S&P 500 lost just over 56% between October 2007 and March 2009 and the pandemic-related downturn in early 2020. Working in investors’ favor, however, has been the remarkably strong stock market performance of the last three calendar years in addition to the almost 10 years of market gains prior to 2018.

The portfolio in this scenario declines to about $326,000 in February 2009, but a subsequent period of strong market growth helps it rebound—in this case, to over $837,000 as of year-end 2021. (See Fig. 3.)

This investor is about 14 years into a 30-year retirement horizon and appears well positioned to tackle future uncertainty even as their portfolio balance dropped to about $829,000 by March 31, 2022. Using a Monte Carlo projection model to assess the next 16 years of retirement,5 we find the portfolio will accommodate continued spending, resulting in a simulation success rate of more than 95%. Additionally, the portfolio is poised to accommodate higher inflationary environments, maintaining simulation success rates of 95% or higher at 5%, 7%, and even 9% inflation throughout the rest of the retirement horizon.

And, stress testing the portfolio assuming a 20% drop of the balance to $663,688 and inflating future spending amounts by 9% over the next 16 years, the simulation success rate does drop to 79%. While it is a significant drop, it’s still within a moderate range of confidence.

It is important to reassess the situation each year. For example, should the market continue to slide and a high inflationary environment persist, then spending adjustments may be warranted, but the approach can be measured rather than a panicked response.

(Fig. 3) Scenario 3: Retiring in 2008

Working in the favor of 2008 retirees is the strong stock market performance of the last three calendar years in addition to the almost 10 years of market gains prior to 2018.

Working in the favor of 2008 retirees is the strong stock market performance of the last three calendar years in addition to the almost 10 years of market gains prior to 2018.

Approaching Retirement and the Unknown

The idea of retirement itself may be overwhelming for many investors. And for those nearing or in retirement, it can be unsettling to see the market tumble. History has shown that down markets have typically been followed by healthy market recoveries. Investors have benefited from unprecedented market gains over the last dozen years. As a result, their portfolios may be able to withstand inflationary pressures and higher spending needs over the short term.

Additionally, these scenarios assume the investor didn’t adjust their behavior due to the inevitable anxiety steep market losses likely caused. It’s human nature to adapt and adjust, and retirees would likely want to modify their plans in some way. In fact, our research shows that, on average, every year from age 65 onwards, inflation—adjusted retiree spending goes down about 2%.6 If investors feel the need to make changes, systematic adjustments to spending can help sustain portfolio balances throughout retirement. These seem like actions most retirees expect to make, which could give them an even larger margin of safety in the long term.

By following a conservative withdrawal approach early in retirement and planning for temporary adjustments along the way (if needed), retirees can weather the markets and have a truly fulfilling and enjoyable next phase of life.

Assumptions:

The hypothetical examples above are based on the performance of the S&P 500 Index, which tracks the performance of 500 large-company stocks, and the Bloomberg U.S. Aggregate Bond Index, which tracks domestic investment-grade bonds, including corporate, government, and mortgage-backed securities, for the time periods represented. Indexes are unmanaged, and it is not possible to invest directly in an index. These hypothetical examples are meant for illustrative purposes only and do not reflect an actual investment, nor do they account for the effects of taxes or any investment expenses. Investment returns are not guaranteed, cannot be predicted, and will fluctuate. All investments are subject to risk, including the possible loss of the money invested.

IMPORTANT: The projections or other information generated by the Monte Carlo analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The projections are based on assumptions. There can be no assurance that the projected results will be achieved or sustained. The charts present only a range of possible outcomes. Actual results will vary with each use and over time, and such results may be better or worse than the projected scenarios. Clients should be aware that the potential for loss (or gain) may be greater than demonstrated in the projections.

1Benchmark reflects the Bloomberg Government/Credit U.S. Bond Index for the period 1973–1975 and the Bloomberg U.S. Aggregate Bond Index from 1975 to the present.
2Consumer price index, seasonally adjusted.
3We used the Monte Carlo analysis and assumed the following: an 87-year-old living with no spouse/partner in retirement with a balance of $508,361 as of 3/31/22 and a hypothetical portfolio composed of 60% stocks and 40% bonds and ongoing monthly withdrawals from the portfolio starting at $2,753 and increasing 3%, 5%, 7%, and 9% annually to account for inflation. This resulted in a simulation success rate (i.e., the investor has at least $1 remaining in the portfolio at the end of retirement) of 99% in each of the 4 examples based on 1,000 market scenarios. No Social Security or other income was considered as we were only assessing the impact of withdrawals on personal savings. To assess a further decline of 20%, we decreased the starting portfolio balance to $406,688 and increased the $2,753 monthly withdrawal amount by 9% annually which resulted in a simulation success rate of 93%.
4Source: U.S. Bureau of Labor Statistics, “Consumer Price Index–May 2022”
5We used the Monte Carlo analysis and assumed the following: a 79-year-old living with no spouse/partner in retirement with a balance of $829,610 as of 3/31/22 and a hypothetical portfolio composed of 60% stocks and 40% bonds and ongoing monthly withdrawals from the portfolio starting at $2,198 and increasing 3%, 5%, 7% and 9% annually to account for inflation. This resulted in a simulation success rate (i.e., the investor has at least $1 remaining in the portfolio at the end of retirement) of 99%, 99%, 98% and 95% respectively based on 1,000 market scenarios in each example. No Social Security or other income was considered as we were only assessing the impact of withdrawals on personal savings. To assess a further decline of 20%, we decreased the starting portfolio balance to $663,688 and increased the $2,198 monthly withdrawal amount by 9% annually which resulted in a simulation success rate of 79%.
6Source: T. Rowe Price estimates from Health and Retirement Study (2001–2015).

Important Information

This material is provided for general and educational purposes only and is not intended to provide legal, tax, or investment advice. This material does not provide fiduciary recommendations concerning investments; it is not individualized to the needs of any specific benefit plan or retirement investor, nor is it intended to serve as the primary basis for investment decision-making.

The views contained herein are those of the author as of July 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

Source for Bloomberg index data: Bloomberg Index Services Ltd. Copyright © 2022, Bloomberg Index Services Ltd. Used with permission. Past performance cannot guarantee future results. All investments involve risk. All charts and tables are shown for illustrative purposes only.

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