When the Dow Jones Industrial Average plunged 387 points on August 9th following the disclosure that turmoil in U.S. mortgage and securities market had prompted a credit squeeze at one of France’s biggest banks, retiring boomers who have nest eggs heavily invested in equities might well have questioned whether carefully prepared plans for drawing down those assets needed to be revisited.
The issue is no small matter. A prolonged bear market, say experts, could wreak havoc with boomers’ retirement funds absent appropriate adjustments to distributions to cushion the shock of the downturn. A chief reason is the timing of returns: Two portfolios that yield the same total return over a 20-year period and that are drawn down at the same annual rate can yield widely varying results because of the differences in the sequence of returns from year to year.
“Most people don’t realize the tremendous impact of the timing of returns when they’re doing withdrawals,” says Michelle Hoesly, a chartered financial consultant and principal of Resource 1, Norfolk, Va. “If bad returns happen during the first 5 years of distribution, many times there is no way for the client recover. But if poor returns come later in the distribution phase, then the client is in a better position financially.”
Hoesly calls to mind a hypothetical client who starts with a $1 million retirement account invested in the S&P 500 Index, drawing $75,000 against the account during the first year and increasing withdrawals each subsequent year to adjust for inflation. When the portfolio returns are negative at the start of retirement and positive during the final years, the client runs out of money during the 17th year. When the sequence is reversed, the client enjoys an ending balance of nearly $5 million–even though the total returns for the two portfolios are identical.
To guard against the first scenario, Hoesly suggests that advisors counsel boomer clients to adjust distributions in tandem with swings in portfolio returns. When returns are down, clients should “put distributions on a diet;” when returns are strong, they may allow themselves “a cost-of-living raise.” Hoesly observes that if the client who starts with negative returns in the above example were to reduce distributions by 3% during the first 5 years and take a 3% COLA increase during the last 5 years, he or she would complete the 20th year of retirement with a $1 million balance–the same amount as at the start.
Life insurance and other financial services companies should consider revising their products to allow (per the client’s written approval) for automated adjustments to distributions from clients’ retirement accounts, Hoesly adds. But not all advisors support this approach.
“I don’t think it’s a good idea,” says Robin Tull, a principal and president of Tull Financial Group, Chesapeake, Va. “You can add anything onto a policy–usually at extra cost. But advisors like myself are here to map out life’s journey and make adjustments along the way. That’s what we get paid for.”