As you consider your investment time horizon—how long your money needs to last—it’s crucial to understand how withdrawals will affect your portfolio. Many retirees may have unrealistic expectations about how much they can safely withdraw each year. Some believe that withdrawing 10% annually is sustainable, thinking that equities’ historical annualized return of roughly 10% supports this approach. However, this assumption is incorrect. While equities may indeed average around 10% over the long term, returns can fluctuate significantly from year to year. If you miscalculate withdrawals during a market downturn, you risk depleting your principal. For instance, if your portfolio drops by 20% and you withdraw 10%, you would need about a 39% gain just to return to your original value.
Inflation
Inflation is another critical factor to keep in mind. It quietly erodes purchasing power over time, diminishing the real value of savings and investment returns. Since 1925, inflation has averaged about 3% per year. If this trend continues, someone who needs $50,000 annually for living expenses today would require nearly $90,000 in 20 years and around $120,000 in 30 years to maintain the same purchasing power. Understanding these dynamics is essential for creating a sustainable retirement plan that preserves your wealth over the long term.
*Source: Global Financial Data, as of 04/05/2023. Based on annualized S&P 500 Total Return Index returns from 12/31/1925 to 12/31/2022. **Source: Global Financial Data, as of 03/21/2023. United States Consumer Price Index from 12/31/1925 to 12/31/2022; average annualized inflation was 2.94%
Sequence of Return Risk
Another factor is sequence of return risk. Sequence of return risk refers to the danger that the “timing” of market downturns or negative market years will have a detrimental impact on the overall value of the portfolio. More importantly, there’s a question of how long the money will last. And this is something that the ATS software (Link to ATS page) aims to protect against the sequence of return risk.
When you’re making withdrawals during retirement, the timing in which your investment returns occur can significantly affect the longevity of your portfolio. A few early years of poor returns, coupled with withdrawals, can reduce the portfolio value, and increase the chance of running out of money much faster than expected, even if the market eventually recovers. Strategies like reducing withdrawal rates, maintaining a balanced portfolio and possibly working longer, before retiring, can help mitigate the risk of running out of money.
