Systematic Withdrawals in Retirement: Understanding the Risks
What Are Systematic Withdrawals in Retirement?
Many of us grew up learning that making regular, periodic contributions to a retirement account is a sound investment strategy. The concept—known as dollar-cost averaging—works like this: by investing a set amount at regular intervals in a fluctuating market, you buy more shares when prices are low and fewer shares when prices are high.
Does the same logic apply in reverse—can taking regular, periodic withdrawals during retirement work just as well?
Not necessarily. In fact, systematic withdrawals in retirement can create the opposite effect, and that difference matters.
How Systematic Withdrawals Work Differently Than Systematic Investing
A systematic withdrawal strategy does the precise opposite of systematic investing. Instead of buying more shares at low prices, retirement portfolio withdrawals sell fewer shares when prices are high and more shares when prices are low. This reduces the number of shares remaining in your portfolio to participate in any future market recovery.
An Example of the Math Behind Withdrawal Risk
Consider how a market decline affects a portfolio differently depending on whether you’re contributing or withdrawing:
- Accumulation phase: If a portfolio falls 25%, it generally needs a return of about 33% to recover to its pre-decline value.
- Distribution phase: If you withdraw 5% of your portfolio for income and the portfolio experiences the same 25% decline, it may need a rebound of roughly 43% to return to its pre-decline value.
This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.
Sequence of Returns Risk in Retirement
Why Sequence Matters More Once You Retire
During the accumulation phase, investors tend to focus on their average annual rate of return, paying less attention to the sequence in which those returns occur. If you’re a buy-and-hold investor still building your portfolio, looking past short-term fluctuations can be a reasonable long-term approach.
Once you’re in retirement, though, sequence of returns risk becomes a critical factor.
Here’s why: Two portfolios can deliver the identical average annual return over a 20- or 30-year period, yet produce very different outcomes for account balance and income—depending on when the gains and losses occur. Generally speaking, negative returns early in retirement can reduce how long your assets are likely to last, since you’re withdrawing income from a shrinking balance during a downturn.
Why Retirement Withdrawal Strategies Require Careful Planning
As American writer H.L. Mencken once observed, “For every complex problem there is an answer that is clear, simple, and wrong.”
Planning for a lifetime of withdrawals from a defined pool of assets over an indefinite period is a genuinely complex challenge—one without a simple, one-size-fits-all solution. Successfully navigating sequence of returns risk often requires creative retirement income withdrawal strategies and ongoing attention to your portfolio and spending needs.
Getting Help With Retirement Portfolio Withdrawals
Because sequence of returns risk can significantly affect how long your retirement savings last, it’s worth working with a financial professional to build a withdrawal strategy suited to your specific goals, time horizon, and risk tolerance. For retirees in Fort Myers, FL and throughout Southwest Florida, a fee-only fiduciary financial planner can help evaluate withdrawal approaches designed to help your assets last throughout retirement.
Frequently Asked Questions
What is a systematic withdrawal strategy in retirement?
A systematic withdrawal strategy involves taking regular, periodic withdrawals from a retirement portfolio to generate income. Unlike systematic investing, which buys more shares at low prices and fewer at high prices, systematic withdrawals do the opposite—selling more shares when prices are low and fewer when prices are high, which can reduce a portfolio’s ability to recover after a downturn.
What is sequence of returns risk?
Sequence of returns risk is the risk that the order in which investment gains and losses occur—rather than just the average return—can significantly affect how long retirement savings last. Negative returns early in retirement tend to be more damaging than negative returns later on, since withdrawals are being taken from a shrinking asset base during the downturn.
Why is withdrawing money in retirement riskier than contributing during your working years?
When you’re contributing to a portfolio, a market decline requires a smaller subsequent gain to recover, and dollar-cost averaging can work in your favor by buying more shares at lower prices. When you’re withdrawing income in retirement, the same market decline combined with ongoing withdrawals typically requires a larger rebound to return the portfolio to its prior value, since fewer shares remain to benefit from the recovery.
How much can a 25% market decline affect a retirement portfolio taking withdrawals?
In a hypothetical example, a portfolio that falls 25% during the accumulation phase might need about a 33% return to recover. If that same 25% decline occurs while withdrawing 5% annually for income, the portfolio may need closer to a 43% rebound to return to its pre-decline value. This is for illustrative purposes only and isn’t representative of any specific investment.
Can dollar-cost averaging protect my portfolio from market losses?
No. Dollar-cost averaging does not protect against a loss in a declining market or guarantee a profit in a rising market. It simply involves investing a fixed amount at regular intervals regardless of price. Investors should evaluate their financial ability to continue making purchases through periods of both declining and rising prices.
Disclosures:
- Dollar-cost averaging does not protect against a loss in a declining market or guarantee a profit in a rising market. Dollar-cost averaging is the process of investing a fixed amount of money in an investment vehicle at regular intervals, usually monthly, for an extended period of time regardless of price. Investors should evaluate their financial ability to continue making purchases through periods of declining and rising prices. The return and principal value of stock prices will fluctuate as market conditions change. Shares, when sold, may be worth more or less than their original cost.
- This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.
- Source: BrainyQuote.
