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Rethinking Risk in Retirement Planning

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What You Need to Know

  • Typically, retirees who don't achieve the income they had hoped for don’t run out of money; they adjust.
  • Even large market crashes, if followed by recovery, do not impair long-term retirement income.
  • Clients must understand that spending needs are spread out over time, and some planned spending is flexible or optional.

Risk in retirement is often presented as the risk of catastrophe. An advisor recently asked if you would get on a plane if you knew there were a 5% chance of a crash. No? Then why would you accept a 5% chance of failure in retirement?

This framing of risk is fundamentally flawed. Typically, if retirees “fail” to achieve the income they had hoped for, they don’t run out of money. They don’t experience financial ruin. They adjust — just as they would have during their working years.

Retirement risk is better than the chances that your flight will be delayed or even canceled. Historically, small adjustments would have saved almost any reasonable retirement plan. Downward income adjustments are inconvenient — maybe even painful. But they don’t mean financial ruin. You will still reach your destination.

Retirement Isn’t a Hedge Fund

Over the past few decades, individual investors have gained access to investment expertise and products that were once the domain only of elite institutions. While this access has mostly been positive, it’s important not to be confused by concepts of risk that work well for (some) institutions but are much less useful in planning for retirement.

For example, a highly leveraged hedge fund might fixate on the risk of short-term market losses. If this risk is not well managed, liabilities could emerge in a fast-moving market drawdown that the fund could not meet in the short term, leading to financial collapse.

This is simply not the way liabilities are structured in retirement. Instead, retirees’ spending needs tend to come in small packages: Think about monthly utility and insurance bills or trips to the supermarket and the gas station. As long as investors can meet these small, ongoing liabilities with matching small, ongoing cash flows, retirement income is not in jeopardy.

This means that even large market crashes, if followed by recovery, do not impair long-term retirement income.

Since 1928, there have been five rapid U.S. stock market crashes of 30% or more:

  1. Crash of 1929: -39% (October-November 1929).
  2. Great Depression: -34% (September-October 1931).
  3. Crash of 1987: -31% (October 1987).
  4. Great Recession: -31% (September-October 2008).
  5. COVID-19 pandemic: -33% (February-March 2020).

The graph below shows how portfolio balances would have developed for hypothetical couples who retired six months before these crashes. These couples followed the well-known (though flawed) “4% Rule” and took $40,000 per year from a portfolio worth $1 million at retirement (all in inflation-adjusted dollars).

No couple came close to running out of money. Their liabilities were small and spread out, so a large market crash (or even two) was not enough to derail retirement. Though not much time has passed since the two most recent crashes, the evidence so far suggests that even the global financial crisis of 2008 and the 2020 COVID crash have not destroyed retirements. 

Bend to Avoid Breaking

Unlike the case of the highly leveraged hedge fund, retirees can adjust the size and timing of many retirement liabilities after a risk occurs. People can cancel or postpone a vacation or change a dinner date at a steakhouse to hamburgers at a brewpub. This flexibility would be akin to a hedge fund retroactively deleveraging its positions after a market drawdown: impossible for the hedge fund, but run-of-the-mill for a retiree.

Research shows that, historically, virtually any sound financial plan (where the initial income level leaves a buffer to absorb risk) could have been saved through relatively minor adjustments, even in the worst of historical scenarios. Take as an example a couple who retired in 1966, just before a prolonged period of high inflation and low real returns, with a portfolio worth $1 million in 2021 dollars. 

Imagine this couple began retirement with $45,000 a year in portfolio withdrawals and a plan to adjust these withdrawals for inflation over time. This couple could have made just a single reduction in nominal income (in 1975) along with two less-than-full inflation adjustments (in 1980 and 1981) and kept well clear of ruin. They would have retained over $800,000 in portfolio balance after 30 years (just under $200,000, adjusted for inflation).

Today’s static financial planning platforms, however, don’t allow advisors to build contingencies and adjustments into financial plans, and they certainly don’t simulate or demonstrate what retirement could look like if it included adjustments. Instead, clients typically see graphs of simulated static retirement plans that show some portfolio balances going to zero. 

Faced with a graph like this, it is difficult for clients not to think that financial ruin is a meaningful possibility. Because it doesn’t reflect realistic adjustment behavior, this graph suggests (inaccurately) that retirement really is like a hedge fund. Unfortunately, it is difficult to overcome this impression, no matter how an advisor tries to reassure the client that “failure” just means “adjustment.”

To help clients truly understand risk in retirement, it is best to avoid the concept of failure and comparisons to plane crashes. Instead, clients are better off understanding the factors that make retirement income so resilient: Spending needs are spread out over time, and some planned spending is flexible or optional.

Reframing the stale discussion of retirement income risk from one of success and failure to one of (minor) adjustments will provide clients with a more realistic view of their retirement journeys so they can worry less and enjoy life more. 


Justin Fitzpatrick is co-founder and chief innovation officer of Income Lab.