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Retiring on a stock portfolio is the luck of the draw

There’s a reason the weatherman ignores averages. In Arizona, a 40 degree morning can become a 90 degree afternoon. It doesn’t help much to know the average will be 65. Yet many stock investors talk about a 9% average as though it can be counted on.

In truth, the irregularity of market returns has a huge impact on your retirement. If you had retired in 1988 (just after the crash of ‘87) with $1 million in stocks, you would have had over $5 million by 2000, and the crashes since then wouldn’t have phased you much. But if you had retired in 2000, those same bear markets meant that even modest withdrawals would have depleted your account to zero with 16 years. This is with the same exact retirement plan, and in both cases stocks went up in the long-run, but in one instance you got rich, and in the other you ended up poor, just from the luck of the draw.

The following charts assume that you retire with $1 million in an S&P 500 index fund. You withdraw $50,000 in the first year of retirement and increase withdrawals at the rate of inflation to keep up with living expenses.

 

Lucky timing

Unlucky timing

The reason is that when you take $50k out of a portfolio that has fallen to $500k, you are withdrawing 10% of your principal. Now even if the market rallies back to even, your depleted account won’t. The lucky 1988 retiree experienced the same 50% declines in portfolio value, but his account had grown to several million by that time, so the withdrawals were only about 2% of the balance.

Stocks have had a good run since 2009, but every bull market comes to an end. The trouble is, nobody on Earth can tell you when a routine dip will turn into a 30% decline, or if a 30% decline will turn into a devastating loss.

The US stock market has lost over 30% nine times in the last 100 years. If those were just quick blips, they could almost be ignored, but there have also been nine times when the market has gone down and stayed down for five years or more. Few retirement accounts are big or robust enough to withstand a bear market.

 

But what if there were a portfolio that resulted in essentially the same positive outcome for those who retired in 2000 as for the lucky cohort who retired in 1988?

Just as before, these charts assume withdrawals of $50,000 in year 1, increasing at the rate of inflation each year. The robust portfolio here is a global mix of US stocks, foreign stocks, REITs, corporate bonds, Treasury notes, and gold. A simple moving average stop-loss is applied to reduce the downside in each asset class. Fees and fund costs totaling 1.5% per year are included.

A robust global portfolio with strict risk controls may not always keep up with stocks, but it is far less likely to put you in a hole when you can least afford it.

 

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