How Do I Manage Timing of Withdrawals in Retirement?

by Beck Bode Beck Bode | August 23, 2022

How do you approach addressing a scenario to which there is no definitive answer? Our business is rife with questions like this, where the answer to these questions is most often, “Well, it depends.” One of the topics that frequently comes up with clients' concerns is the “sequence of return risk.”

 

What is Sequence of Return Risk?

Sequence of return risk is the technical phrase for how the timing of withdrawals in retirement can actually increase longevity risk — the potential for outliving your money. This is particularly worrisome to anyone who is looking to make a withdrawal from their investments at a time when market declines could affect the long-term viability of their portfolio. What would happen if you planned to retire next year, your investment portfolio is chugging along, and suddenly there was a market drop of 40%? 

Depending on your ability to handle this kind of market movement, on the emotional spectrum, you may find yourself somewhere between “worried” and “all-out panic.” This could lead to making emotionally-charged decisions that further compound the problem. 

No matter how sequence of return risk is explained, this quite possibly produces the greatest apprehension for clients who are in or nearing retirement. If you’re having a personal meltdown because of this, can I blame you for your reaction? Absolutely not. It is a fact: sequence of return risk can indeed impact a client’s ability to take income from their portfolio. Some clients may have to take less income in subsequent years after a downturn until their portfolio can recover from the drop. The good news is that there are strategies to deal with this.

 

How Do Traditional Advisors Deal With It?

 

Traditional Advisors Recommend Investing in Bonds 

There are a few ways that traditional advisors address this issue. One is to take less income from the get-go. For example, establish a 3-4% fixed withdrawal rate from day one. This is typically coupled with the recommendation that you “diversify” using fixed income instruments, aka bonds. If you haven’t read what we have to say on why NOT bonds, this would be a good time to catch up on those posts. 

Bonds are not the answer, because all they do is anesthetize you into thinking you’re in a better place when really, you’re not. They’re the investment equivalent of a sedative: who are we kidding though, the injury is still there. 

 

Traditional Advisors Recommend You Buy Into an Annuity

OK, so not bonds. Then what? If you’ve ever run across an insurance agent who sells annuities of any kind, you may be familiar with their response to sequence risk. The insurance agent will tell you that the way to address this kind of risk is to buy into an annuity with a “guaranteed lifetime income rider.”

For a small fee (thinly veiled sarcasm there) you can have a “guaranteed income stream: for the rest of your life, and don’t have to worry ever again about the stock market crashing. Turns out that option works pretty well for the insurance agent -  though not as well for the client who just gave away their life savings to be controlled by an insurance company. Thanks, but no thanks.  

We know the whole reason to invest is to reap potential gains. Amid an industry that seemingly champions, more than anything else, an “invest to not lose” mentality, I firmly believe that it is our duty to remind/persuade clients that they have to participate if they want the rewards. But that doesn’t mean that we can’t be smart about it. 

The smartest thing to do is to recognize the reality of the situation. Emotion and logic don’t mix well. If you question my line of reasoning, consider arguing logically with a two-year-old. I have direct experience with this. I’ve failed every time. You’re not going to get anywhere before you acknowledge what the clients are going through. 

 

The Importance of Acknowledging People’s Real Feelings About the Markets

I’m reminded of some of my favorite TV shows…. legal dramas. In the most consequential of situations, when do you see the star attorneys ever avoiding the elephant in the room? NEVER. The best lawyers address directly the fears, concerns, and reservations of the jury…often as early as in the opening statement. In our case, that elephant is the client’s emotions. It’s human. It’s fear. The best financial advisors address their clients’ fears. (Does yours?)

We all experience fear, even advisors have. Just like the sharpest attorneys, the most capable advisors have the courage to name exactly the thing that their clients resist to articulate. Not to equate a client’s decision-making process to a courtroom scenario, or to a power struggle with a toddler over having another chocolate milk. What I’m getting at is that we have to speak to the fear first, before we can make an appeal to logic. 

Yes, sequence of return risk is a real thing. To address the fear about market declines early in retirement, we typically have a conversation about the client’s need for withdrawals. Since in most cases we have gone through the entire financial planning process, we have a pretty good understanding of this client’s cash flow. 

 

Understand That the Perfect Solution Does Not Exist 

Let’s say you have retired and are no longer working. You need enough to cover your lifestyle needs in the event of a market downturn.. 

We may recommend keeping in cash anywhere from a year to two years’ worth of withdrawals. So, there’s money available just in case that perfect storm of a market downturn does take place as you venture into retirement. This is sometimes referred to as the “bucket” approach: separating the client’s assets into buckets of money, each bucket earmarked for different time periods. Now, is this a great “logical” solution? 

No, not really, because that’s one- or two years’ worth of cash that isn’t invested. Cash on the sidelines is not benefiting from any upward market movement. But is it a solution to your emotional needs? In other words, does it allow you to sleep at night? I bet it does.

The fact of the matter is that no perfect solution exists for managing sequence of returns risk…much less anything else in our industry. A number of different strategies can address retirement income needs and limit the impact of sequence risk, but there are downsides to each strategy. 

 

Our Perspective on Sequence of Returns Risk

What we can (and do) at Beck Bode is acknowledge people’s very legitimate feelings, and then provide them with perspective. There are two places where we simply can’t go wrong when dealing with people and money. 

First is to have the audacity to be truthful — the courage to say it like it is: “Yes, Mr. and Mrs. Jones, we have some risks here that we can’t fully protect you from…at least without altering (maybe considerably) your longer-term performance.” Or: “Yes, you may have to carve out a chunk of your savings and move it into cash, which will affect your overall return.” 

Secondly, we show empathy for whatever it is you, the client, are going through. Nothing builds credibility like honesty and showing that we are all human. 

If you’re ready for perspective on the sequence of returns risk for your portfolio and other retirement planning considerations, check out our retirement planning guide.

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