- They each retire with a $500,000 portfolio.
- They each withdraw 4% of their portfolio in the first year of retirement, then adjust that amount upward each year to account for inflation (as measured by the Consumer Price Index).
- Their portfolios are identical: 60% in Vanguard Total Stock Market Index Fund and 40% in Vanguard Total Bond Market Index Fund, rebalanced at the end of each year.
- The only difference is that Leslie retired at the end of 1994, and Bob retired at the end of 1999.
- 10 years into her retirement, Leslie’s portfolio had more than doubled, with an ending value of $1,062,606. (And 5 years after that, it had grown further to $1,105,982.)
- 10 years into his retirement, Bob’s portfolio was worth only $400,354.
They each followed the rules (more or less) with fairly conservative, low-cost portfolios, rebalanced annually. Yet because of when they retired, their retirements look very different.
Leslie will be (mostly) free from money worries, and she’ll be able to give generously to her children, grandchildren, and charities of choice. In contrast, Bob will have to be careful so as to avoid running out of money.
Why such a difference?
For the first few years of Leslie’s retirement, the stock market was shooting upward. In contrast, Bob’s retirement began with a 3-year bear market. When Leslie liquidated investments to pay for living expenses, she was selling high. Bob was selling low.
By the time the market began to rebound in 2003, Bob had already liquidated a good portion of his portfolio, so he didn’t benefit as much from the bull market as he would have if it had occurred at the beginning of his retirement.
In short, if you follow conventional investing wisdom:
- A bull market in the first few years of your retirement puts you on easy street, yet
- A bear market in the first few years of your retirement can mean money worries for the rest of your life.
Ways to Protect Yourself
What can you do to avoid finding yourself in Bob’s position during retirement?
1) Most importantly, lower your withdrawal rate. Many experts argue that a 4% withdrawal rate involves taking on very real risk of outliving your money.
2) If you don’t have enough saved to use a withdrawal rate lower than 4%, annuitizing a portion of your portfolio can be help reduce the chance of outliving your money. (On the other hand, it also reduces the amount you’ll end up leaving to your heirs.)
3) Take valuation levels into account when determining your asset allocation. In other words, it was a mistake for Bob to have 60% of his portfolio in stocks at 1999 price levels.
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About the Author: Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $175,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
Updated for 2018 and beyond.