As the COVID-19 pandemic and market volatility continue, advisors need to speak to clients about shifting withdrawal rates, according to two retirement experts who spoke during a recent ThinkAdvisor webcast.
“The first quarter was really a wild ride for equity investors,” David Blanchett, head of retirement research for Morningstar’s Investment Management Group, told listeners, adding “we’re in a really unique time” right now.
Clients who have been accumulating their wealth for 30 or 40 years are those who are most affected by the current turmoil.
Blanchett and Michael Finke, director of the Wealth Management Certified Professional program at the American College of Financial Services, explored how buffer assets can affect retirement income success and why retirement specialists now are taking a more nuanced view of “safe” initial withdrawal rates than in past years.
Risk and the 4% Rule
The pandemic has highlighted one portfolio weakness — namely, it “almost seems as if risk is not a real concept” to many clients anymore, according to Finke. After all, for the past decade, “the market’s pretty much” done nothing but “go up,” he noted.
When many clients see analysis claiming they have a 94% chance of success in retirement, they think that means there’s a 94% likelihood they can maintain their lifestyle throughout retirement, Finke explained.
Also, many believe that if they’re relatively conservative at the start of retirement, they’ll be relatively fine through retirement — no matter what.
“But the reality is you get unlucky, and that’s what risk means,” he pointed out. “If you’re going to take risk in retirement with your investment portfolio, then that means that there’s a possibility that you could draw the wrong card the first year.”
As an example, Finke pointed to a Monte Carlo simulation in which a client retired Feb. 20 and chose a 3% withdrawal rate under the 3% rule. “You would have had a 94% chance that you could maintain, say, $30,000 plus inflation each year in retirement from a million-dollar portfolio” at that point, he said.
However, by the time that client got to March 12, he or she would have had only a 64% chance to maintain that same $30,000 plus inflation each year in retirement, Finke explained.
That underscores why the traditional methodology of thinking about retirement withdrawals from a risky portfolio to fund a safe and stable income in retirement is “not exactly realistic,” Finke said.
In reality, there are many events that happen during the course of one’s retirement that affect this scenario. “Those events will change your reality every year, and you have to adapt to the new reality,” he noted.
The traditional 4% rule is a “fluke” of the United States in the 20th Century, Finke said. Failing to adjust one’s spending each year in retirement hasn’t worked well in other countries, and it might not work well anymore in the United States either.
This is because of the current “globally diversified marketplace,” he explained, predicting that lower returns across the globe are likely to be the norm in the 21st Century.
Buffer Assets, Other Options
To better manage volatility and longevity in retirement, clients have basically four options, according to Finke:
- Spend conservatively,
- Spend flexibly,
- Reduce volatility and
- Use buffer assets and avoid selling at losses.
Retirees often decrease their spending, some of which is more flexible than it was in their pre-retirement years, Finke explained. Financial advisors shouldn’t assume retirees’ spending will be the same each year, though about 70% of a retiree’s budget is inflexible (as it is tied to food, healthcare, etc.).
Delaying Social Security is an option that can give clients more to spend in retirement, he noted. Clients who have pensions also can withdraw more money safely from the portfolio than those who do not.
A buffer-asset strategy, meanwhile, could have helped counter what happened in March, when bonds fell at the same time as stocks, according to Finke.