The Retirement Timing Trap

Paul Ruedi

Though retirees with a reasonable spending plan can weather a bear market or even multiple bear markets during retirement, if that bear market shows up at the wrong time it can spell trouble. The period retirees are most vulnerable to a bad bear market is in the few years on either side of their retirement date, and they should exercise extra caution when investing during this time period.

The three years leading up to and the three years immediately following retirement are likely the largest a retiree’s account balance has ever been as they have not taken many withdrawals out of their portfolio yet. If a bear market shows up at this time, it can cause retirees to have to sell a larger percentage of their portfolio when it is down to fund their lifestyle, which can fast-track them to depleting their portfolio.

I think it is helpful to understand through an example. Suppose a retiree with a $1 million all-stock portfolio enters retirement planning to withdraw $50,000 per year, and gets unlucky with a 2-year bear market. If the bear market comes along and cuts the portfolio value in half, they would be taking a $50,000 withdrawal from a $500,000 portfolio, a full 10% withdrawal rate. If the market doesn’t come back quicky, just two years of withdrawals will deplete 20% of the remaining portfolio.

Even if the market comes back and doubles rapidly by year 3, that leaves a retiree needing to withdraw $50,000 from an $800,000 portfolio which may not be sustainable. In this example a retiree had to sell so much when the market was down, it put the portfolio on a path from which it could not recover to sustain the original withdrawal rate.

The way retirees can mitigate the risk of bad timing when retiring is by holding a higher percentage of bonds in the few years before and after their retirement date. If a bear market shows up, retirees can withdraw from the bond portion of their portfolio and allow the stock portion of their portfolio to recover.

But bonds won’t produce the rising income stream retirees will need to live in a rising-cost world, so retirees should have a plan for how to return to a higher percentage of stocks to avoid inflation causing problems for them later in retirement. If you don’t have an investment plan that will insulate you from a temporary decline on the front end of retirement, but also provide a rising stream of spending for multiple decades of retirement, you may want to talk to a financial advisor.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.