Retirement Spending in Perspective

Retirees must be rolling their eyes when they see the “great time to buy” comments. Guilty. The “time to buy” camp ignores a class of investors who need much better insights.

While much of the damage has been done already in 2022, there could be more on the horizon. If we’re truly past peak inflation, there’s no telling what other outside factors might shake the markets. However, markets have always been tested by war, inflation, deflation, bubbles bursting, etc. and they still move upwards over a long enough time period. 

This year has been tough for most retirees who aren’t earning wages to invest more. Diversification hasn’t worked because both stocks and bonds sold off. Exacerbated by easy money policies over the past decade, savers had to stretch their risk budgets to earn meaningful yield. While stocks have more than made up for the lack of yield, many retired investors took on more risk than they might have been comfortable with. 

Stock sell offs are generally accepted because there’s a known risk when investing in them. Bonds aren’t expected to behave this way. We’ve been told that bonds are good to hold in case of a stock sell off. But we can argue that bonds, specifically interest rates, were the cause of this sell off. 

Historically speaking, bonds have held up as stocks sold off. Stock investors would sell their stocks and move their proceeds to bonds. The problem this time was starting yields were so low that many investors sold both bonds and stocks as interest rates rose. Cash was the only place to hide, even though 8.5% inflation was eroding its value in 2022.

Note: Above I have used the All Cap Word Index (ACWI) because that is a better representative of a globally diversified portfolio. 

While it was not fun riding bonds 15% down, the silver lining is yields on the aggregate bond index are paying worthwhile yields of nearly 4% as of mid-October. Bond yields are the main driver of returns over longer periods. Losing 15% isn’t fun but that can be made up with coupons in less than four years. That’s assuming bond prices don’t recover and we’re just taking the income.

What is a retiree to do? In terms of asset allocation, I would not change much if the portfolio still fits the risk profile. We have no control over markets, but we have control over many other things. We stress test not only your portfolio but stress test the entire retirement plan. A big assumption (possibly the biggest in terms of impact) will be the level of spending or withdrawing. The 4% Rule (created by Bill Bengen 1994) is a good starting point because most portfolios will typically average a return that can stay ahead of that distribution rate. 

The average expected return on a portfolio is just that, average. Some years will be lower than the expected return and some years will be higher. It’s rare for year to be “average”. Unless you think you will spend all your retirement savings in one year, a tough year like this should be expected and eventually recovered. 

Back to the 4% Rule. It assumes 4% is the starting point and spending will increase each year with inflation so there is a need to keep a portion of assets invested in stocks. This is a conservative approach to retirement spending, with good reason. Life spans are long and lots of things can potentially go wrong, so planning conservatively gives us room for life’s surprises. In fact, many retirees don’t spend enough in retirement with the typical withdrawal rate well below the actual returns their portfolios produce. Some can go years without withdrawing until they’re forced to (RMDs – Required Minimum Distributions). 

Even with the 4% Rule being shown as historically conservative, retirees tend to be even more conservative in withdrawing their money. The following charts are from Greenwald and Associates where they surveyed household spending habits. 

The question then becomes how much is withdrawn on an as-needed basis and how often? The next chart suggests that retirees will adjust other categories before taking money from retirement savings. The majority will reduce spending before touching their investments. When they do withdraw, 58% draw less than wait their investments earn, and 26% withdraw up to the amount earned, and only 14% drew down principal.

There’s a difference between spending cash, versus cash as an investment. Spending cash, when scaled properly, can help retirees get through tough periods like 2022. We will set spending targets and make sure there’s enough money in checking accounts to avoid drawing down in bear markets. There will be good and bad years when filling these cash buckets. The point is we want to avoid forced selling. Cash as an investment is considered for just that, an investment. If an investor has cash in an investment portfolio, there’s a market timing element here that we stay away from. 

If this market is costing you sleep, there’s not much we can change now. Understand that down years will happen and a rebound will give many the opportunity to address their portfolio risks. There will be several more bear markets your portfolio will need to withstand. Just because bonds failed this time, it doesn’t mean they won’t hold up during the next stock sell off. Staying invested and properly diversified are going to be key for future bull and bear markets.  

DISCLOSURES: 

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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