If you're making withdrawals from your retirement account, you need to ask yourself (and your adviser) some tough questions—and to take a good hard look at the numbers.
No doubt about it: The market has had a brutal couple of months. It’s upsetting to check your retirement account and see that some sectors are down as much as 40-50 percent. Granted, some weeks of upswings have been a welcome respite — but is the downward pressure over?
Is a big rebound coming? Retirees who rely on their investments for income may not want to hang around to find out, says Peter Mougey.
“Retirees who make regular withdrawals from their portfolio have specific risks that younger investors don’t need to worry about,” says Mougey, national securities and investment fraud attorney with Pensacola, Florida’s Levin, Papantonio, Thomas, Mitchell, Rafferty & Proctor, P.A. “If you’re in this category, you’ll want to talk to your financial adviser right now. Don’t keep blindly moving ahead, hoping to catch the rebound. And don’t leave their office until you’re sure you understand the math.”
Mougey suggests asking your adviser the following questions.
1. Is my portfolio at risk for the death spiral? (Show me the math!)
Withdrawals in a declining market make it difficult to rebound.
Let’s look at a scenario where you’re withdrawing way more than 4 percent a year from a portfolio that’s $100,000 and heavily weighted to stocks. Right now, due to the coronavirus market, you could be down to $80,000. If you are also taking out $1,000 per month, or 12 percent since the beginning of the year, it is possible your life savings has declined to $75,000.
If the market continues its gyrations while you make $1,000 monthly withdrawals to the year-end, your portfolio could be close to $60,000.
Next year, in order to support this $1,000 per month withdrawal, your portfolio would need to return 20 percent. This is almost impossible over the long term. To recover to the $100,000 and support the withdrawal, the market would need to bounce approximately $50,000, or almost 80 percent, to return to $100,000. If the market declines, older, retired investors making regular withdrawals may find themselves in a deep hole, Mougey says.
“The golden rule of investing while taking withdrawals: Don’t go backward to the point recovery is impossible,” says Mougey. “And to avoid moving backward, you and your advisor may need to look out for a couple of red flags.”
2. Am I withdrawing too much? (Red flag 1)
First, add up your monthly cash needs throughout the year. If your total cash need is more than 4-5 percent, you are likely withdrawing too much.
Many financial advisers tell retired investors they can rely on the average long-term stock market return. Often the range they rely on is 10-12 percent. This is bad advice, Mougey says.
“I have seen the devastation this advice causes more times than I can count,” he says. “An adviser may say, ‘Why work when your withdrawals are more than you are making now?’ The financial advisor recommends a portfolio of almost all stocks and higher-risk bonds to support taking distributions at this level. It is not a matter of if this advice will end up ruining your life savings; it’s a matter of when.
“The academic and industry literature suggests portfolios can sustain only 4-5 percent over the long term,” he adds. “The farther you get away from 4 or 5 percent, the higher the risk you’ll be involved in a death spiral that you can’t ever recover from.”
3. Is my portfolio too heavily weighted in stocks? (Red flag 2)
If you’re retired and your portfolio is almost all stocks, stock mutual funds and high-yield bonds (often called junk bonds), you are exposed to too much volatility. Granted, stock returns are much higher than bonds, but the additional return comes with much higher risk.
Volatility that comes with stock portfolios, coupled with withdrawals, is a recipe for disaster for retired investors. Quite simply, you don’t have 20 years to allow averages to smooth volatile stock returns.
The sequencing of stock returns is what makes this a game of Russian roulette. Yes, stock returns may average 10-12 percent, but they’re not like a CD that pays the same amount every year.
For example, stocks may have the following returns over four years: Year 1: 15 percent, year 2: 27 percent, year 3: 5 percent, year 4: -10 percent. This is often referred to as the “sequence of returns.” If the positive three years come first, the retiree may have a chance. But if during the first year of retirement, the market declines 10 percent and the investor withdraws 10 percent, the chances of recovery are low. The sequence of returns demonstrates why a retired investor can’t rely on averages.
4. With these factors in mind, should I rethink my approach?
Take the opportunity, with the market creeping back, to determine:
- Whether your withdrawal rate is at a sustainable 4-5
- Whether your mix of stocks and bonds is right.
Your investment-grade bonds allocation should be about your age. For example, if you are 70, then you should have no more than 20-30 percent in stocks.
“Fewer stocks and more investment-grade bonds will reduce volatility, minimize the harm sequence of stock returns can cause, and allow you to enjoy retirement without outlasting your money,” notes Mougey.
Is it time to rebalance your portfolio? Get “skinny” and stop taking withdrawals for a while? Go to cash? It depends on your situation, Mougey says — just make the decision deliberately and with both eyes open.
“Don’t just keep doing what you’re doing and hope for the best,” he says. “These are extraordinary times, and hope is never a strategy. Neither is blind trust in your adviser. Many are great, but some aren’t. Make sure you’re fully aware of the issues and engaged in making the best decision for your life and your future.”
About The Author
Peter Mougey is a partner in the Pensacola-based law firm Levin Papantonio and the chair of the firm’s securities department. He concentrates his practice in the areas of complex litigation, financial services, securities litigation, and whistleblower or qui tam litigation. He advocates for the rights of investors as both the past president and member of the board of directors of the national securities bar, PIABA, which was established in 1990 to promote and protect the interests of the public sector in securities and commodities arbitration. Levin, Papantonio, Thomas, Mitchell, Rafferty & Proctor, P.A., has been in existence for more than 65 years and is one of the most successful plaintiff law firms in America. Its attorneys handle claims throughout the country involving prescription drugs, medical devices, defective products, securities, and consumer protection.