Guide clients on retiring in uncertain markets
May 6, 2021
May 6, 2021
Clients don't always have the luxury of choosing to retire as financial markets are rising. Yet, the timing of clients' transition out of the working world can have a tremendous impact on their retirement savings longevity.
As Vanguard research has shown, sequence-of-return risk—the threat to a successful retirement posed by a concentrated run of poor market performance—can be substantial, especially if it happens early in retirement. This risk can mean lower-than-hoped-for retirement income, early exhaustion of retirement savings principal, or both.
Fortunately, you and your clients can leverage much more than lucky timing to boost their chances of a financially comfortable retirement. Small adjustments to retirement spending, guided by actual market conditions, can go a long way toward boosting the probability of long-term retirement success (that is, spending that's sustainable for life, while affording the client a satisfactory lifestyle). This article examines the dynamic spending strategy for sustaining retirement savings and provides resources to deepen your and your clients' understanding of this important concept.
Ideally, no one wants to enter retirement during a prolonged and significant market decline. After all, a market shock reduces a client portfolio's value, diminishing the amount that can safely be withdrawn. But it's not entirely bad news: By lowering the valuations of securities, the shock can also raise expected returns, potentially offsetting some of this decline. A decline in stock market valuations has tended to be associated with higher future returns.1
In a series of Vanguard Capital Markets Model® (VCMM) simulations, this rise in expected returns meant that the decline in sustainable spending was shallower than the decline in the portfolio's value. At the end of December 2019, VCMM projections suggested that a $1 million portfolio could sustain $45,000 in annual spending, adjusted for inflation (dollar plus inflation rule), for 30 years. In 10,000 simulations, the portfolio met this target 85% of the time. After the market shock, the $1 million portfolio fell to $800,000, a 20% decline. However, as expected returns rose, sustainable spending dropped by less than 10%, to $40,800.2
In simple terms, a comparatively small reduction—by percentage—in annual spending can preserve a portfolio after it's been hit by a much larger market shock.
Further, Figure 1, above, shows that substantially higher annual spending is possible through a flexible approach, calibrated yearly to market conditions (dynamic spending rule).
To help clients in adopting such an approach, it's first helpful to summarize three of the most common spending strategies (Figure 2):
A reduction in annual spending (even a small reduction), can significantly boost the chances of a clients' retirement portfolios lasting the rest of their lifetimes. Further, a dynamic spending strategy provides retirees the flexibility to spend more in good market conditions while they only have to cut back a little when markets retreat.
Note that the calculations here exclude Social Security and other possible income, such as pensions, rental property, or supplemental employment after retirement. Such income streams can enhance the chances of individuals successfully maintaining their portfolio through the end of retirement.
As a financial advisor, you're uniquely situated to help clients understand sequence-of-return risk, and how implementing a dynamic spending strategy can mitigate that risk. You can also remind them that bearish markets are inevitable. While it's impossible to accurately predict when downturns will appear, with your help, clients can take steps ahead of time to minimize the long-term impact on their retirement.
Consult the resources below to explore this topic in greater depth.
Clients worried about the effects a future downturn might have on their retirement plans? Share this client-approved brochure that explains how a flexible approach—the dynamic spending strategy—can help them maintain a comfortable living standard for the length of their retirement, regardless of market ups and downs.
For a deeper analysis of sequence-of-return risk and how to mitigate it for your clients, download the original Vanguard research:
This research note uses the 2020 market shock, which was precipitated by the coronavirus pandemic, to explore hypothetical scenarios for retirement spending withdrawal strategies. Employing the VCMM, this research illustrates how a dynamic spending strategy can mitigate negative long-term portfolio impacts from shocks such as the 2020 market downturn.
1 Khang, Kevin I., Andrew S. Clarke, 2020. Safeguarding retirement in a bear market. Valley Forge, Pa., The Vanguard Group.
2 David Pakula, 2020. Guiding your clients through stormy weather: Sustainable withdrawal rates in times of crisis. Valley Forge, Pa., The Vanguard Group.
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