Tips on Managing Portfolio Drawdowns to Generate Income during Retirement

An important step toward living the retirement you envision is to calculate how much money you can safely withdraw from your savings and investments over time. While Social Security may be a component of your retirement plan, most investors shouldn’t consider it a sole retirement income source. Chances are you will rely on other financial assets after you retire. These could include employer-sponsored 401(k) plans, traditional IRAs, Roth IRAs, taxable accounts, real estate or even annuities. As a retiree, it is important to properly manage and anticipate potential retirement cash flow. If you overlook this step, you could fail to meet your expectations and you could even run out of savings in your time of greatest need. Most retirees depend on their portfolio cash flow to cover their living expenses. To learn more about how to appropriately plan for cash flow and income needs in retirement, read on.

Retirement Income Strategy Management

Retirement income often includes more than what you receive from Social Security, but Social Security can still be an important source of income. To maximize your Social Security benefits, you may be better off waiting to take them until you reach full retirement age. To do this, early in retirement you can lean on other sources of income, such as savings, annuities and retirement plans. These sources can be divided into cash flow and income—an important distinction. Cash flow refers to money withdrawn, whereas income refers to money received (e.g., bond interest and dividends). Income sources are just one way to generate cash flow—cash flow can also be created by strategically selling securities in your portfolio. With that in mind, here are some straightforward steps to creating a successful retirement income strategy.

• First, list all your non-discretionary and discretionary expenses. It is important to distinguish between the two types of expenses, as there may be a gap between what you want to withdraw from your portfolio and what you can sustainably take out over time. Consider which of your non-discretionary spending items are non-negotiable and which you could change. For example, food, shelter and utilities are non-discretionary, but you may be able to find ways to reduce those expenses, if necessary. You may think of your mortgage payment as non-negotiable, but you could downsize your home or move to a cheaper place. That could reduce your monthly payments. Discretionary expenses include hobbies, entertainment and other leisure activities. You may assume discretionary expenses will be kept to a minimum after you retire. But keep in mind that retirees have seven days to spend money on leisure activities, instead of the working person’s two. In addition to these expenses, think about any new expenses you are likely to incur after you retire. Maybe you want to take trips to visit the grandkids or want to spend money on health-related comfort costs. Also, try to plan for the unexpected. Home and car maintenance can be expensive. Saving money for such events means you won’t have to withdraw emergency cash from other retirement accounts such as your 401(k) or IRA and suffer a tax hit.

• Then detail your cash flow sources. Start with your accounts such as IRAs, 401(k)s, savings accounts, mutual funds, stocks in your brokerage accounts, annuities—any investment that generates cash flow. Then consider your non-portfolio income sources (job, pensions, Social Security, etc.).

• Next, determine how much of your planned spending will come from non-portfolio sources and how much you will need from your portfolio. Keep in mind that what you receive from non-portfolio sources such as Social Security and pension may not cover all your non-discretionary expenses in retirement. If you expect to need more than 5% of your portfolio value annually, you may need to revisit and adjust your budget. That could mean making some difficult choices around your areas of discretionary and non-discretionary spending. If you are still in your working years, you may choose to work longer to build more income or savings. Another option could be to plan for part-time employment.

Withdrawal Management at Retirement

After assessing your various retirement income sources, you can focus on managing your withdrawals. Since the market has returned an average of about 10% over time,^[i] some retirees may incorrectly assume they can sustainably withdraw 10% per year. But market volatility can produce wide fluctuations in investment returns from year to year, which can have a big impact on how much you can safely withdrawal. For instance, if your portfolio’s value declines 20% and you take a 10% distribution, your portfolio would need to gain 39% to get back to even.

As a retiree, the last thing you want is to run out of cash. Even a small difference in annual withdrawals can affect your investment portfolio over time. Withdrawing more than 5% annually can reduce the likelihood of financial sustainability, regardless of how you allocate your assets. Exhibit 1 below uses a 30-year Monte Carlo portfolio model and shows the hypothetical impact of 10% and 7% annual withdrawals on a $1,000,000 portfolio of 100% stocks, 70% stocks / 30% bonds and 50% stocks / 50% bonds with corresponding probabilities of success. Values are expressed in today’s dollars.^[ii]

Exhibit 1: Hypothetical Projection of $1,000,000 Starting Value Over 30-Year Time Horizon

Hypothetical $100,000 (10%) Annual Cash Flows

Hypothetical $70,000 (7%) Annual Cash Flows

The Monte Carlo simulation is a non-linear statistical method that, based on random sampling of historical equities, fixed interest and cash returns, allows for the assignment of probabilities to various outcomes. This informational analysis makes numerous assumptions, including but not limited to the use of S&P 500 Stock Index and/or US 10- year Government Bond Index historical returns and our forecasted data for domestic equities, fixed income, cash and inflation to project the ending value of your portfolio in the future or cash flow availability from your assets. All values are expressed in today’s dollars as of 7/30/2018. The index(es) used in this analysis may not be the benchmark(s) selected for clients. No assurance can be given that these returns will be achieved. This analysis is for informational purposes only. It has been formulated with data provided to Fisher Investments and is assumed to be reliable. Fisher Investments makes no claim to its accuracy.^[iii]

Withdrawals of 7% from a 100% equity allocation over a 30-year period show the best performance with 53.6% probability of portfolio survival. That probability may not be enough for most investors. As Exhibit 2 shows below, annual withdrawals of 5% from a 100% equity allocation raise the probability of portfolio survival to 84.7%, and withdrawals of 3% raise the probability to 99.7%. A two-percentage-point reduction in your withdrawal rate can significantly boost the sustainability of your available financial capital.

Exhibit 2: Hypothetical Projection of $1,000,000 Starting Value Over 30-Year Time Horizon

Hypothetical $50,000 (5%) Annual Cash Flows

Hypothetical $30,000 (3%) Annual Cash Flows

These projections show the sustainability of a given withdrawal rate depends on your investment strategy and asset allocation. For instance, if you need your retirement income to last a long time, investing a (perhaps significant) portion of your portfolio in stocks can provide the financial growth potential you require. Without growth, your portfolio can diminish over time through inflation.

Retirement Income Management

Investing and saving for retirement can be a challenge. And managing your retirement income can be a greater financial responsibility, especially if you want to do it yourself. There are several moving parts—Social Security, annuity payouts, savings, withdrawal amounts, retirement income adequacy and so forth. While the guidelines we have provided can be helpful in creating a retirement income strategy, many investors could benefit from professional guidance. For instance, if your cash flow needs change after retirement, determining a safe amount to withdraw can be difficult.

Even if your cash flow needs are straightforward, you may benefit from an investment adviser like Fisher Investments to help you manage an investing strategy and stay disciplined on the path to your longer-term goals. We can assist with management of cash flow and more, tailoring a portfolio that can help you manage your financial needs in retirement. Call us today to learn more.

^[i] Source: Global Financial Data, Inc.; as of 01/12/2018. Based on annualized S&P 500 Total Return Index returns from 12/31/1925 – 12/31/2017.

^[ii] The Monte Carlo simulation is a non-linear statistical method that, based on random sampling of historical stock, bond and cash returns, allows for the assignment of probabilities to various outcomes. This informational analysis makes numerous assumptions, including but not limited to the use of S&P 500 Stock Index and/or US 10- year Government Bond Index historical returns and Fisher Investments’ forecasted data for domestic equities, fixed income, cash and inflation to project the ending value in the future or cash flow availability. All values are expressed in today’s dollars, as of 07/30/2018. The index(es) used in this analysis may not be the benchmark(s) selected for clients. No assurance can be given that  these returns will be achieved. This analysis is for informational purposes only. It has been formulated with data provided to Fisher Investments to be reliable. Fisher Investments makes no claim to its accuracy. Investing in securities involves risk of loss. Past performance is no guarantee of future returns.

^[iii] Source: Global Financial Data, Inc., FactSet, Inc., Bloomberg.