Sunday , 19 November 2017


Is $1,000,000 Enough to Provide for a Successful 30-year Retirement?

The Growth Retiree’s advisor recommended an asset allocation and a withdrawal strategy to meet their goals. The advisor adjusted their asset allocations according to his understanding of Modern Portfolio Theory…believing that the best path to follow was a total return strategy.

Mr. and Mrs. Growth Retiree seemingly had already done the hard part by accumulating the $1,000,000. In a total return strategy, a withdrawal plan is mandatory. That is because the portfolio is not constructed to generate all the income needed. Rather, it is designed to have parts of the nest egg be sold off each year to obtain the cash needed for living expenses. The most common guideline is the 4% rule as described above, with 3% withdrawal increments each year to cover inflation.

Assumptions

In this article I am going… to revisit the situation and run other trials using different assumptions.

  • Instead of the flat 3% return every year, the returns will follow the pattern actually achieved by the stock market in 2000-2009. That 10-year span will simply be repeated to get the 30-year total return sequence.
  • Mr. and Mrs. Growth Retiree requested a conservative portfolio so I use two models to reflect what their advisor has achieved through asset allocation.
    • Model A: Two-thirds of the S&P 500’s returns are achieved each year. This not only reflects the conservative construction of their asset allocation (it’s heavy on bonds), but it also dampens the volatility of their portfolio, as bonds tend to do.
    • Model B: Here, their advisor hits a home run. He manages to out-gain the S&P 500 by 5% each and every year, in good years and in bad.
  • Just for fun, we’ll run the 30-year sequence twice.
    • Trial 1: The sequence will be run forward, just as it happened. This is a real stress test, because the 2000-2009 period started with three bad years.
    • Trial 2: The sequence will be run backward. This produces positive returns in 6 of the first 7 years and should get the portfolio off to a great start in its quest to achieve the Growth Retiree’s 30-year retirement goal.

Other assumptions remain the same:

  • Mr. and Mrs. Growth Retiree start off with $1,000,000 on the day they both retire.
  • Following their advisor’s recommendation, they follow the 4% + inflation rule for making withdrawals from their retirement nest egg.
  • Transaction costs are ignored.
  • Taxes are ignored.
  • Each withdrawal is made at the beginning of the year.
  • The nest egg’s balance at the end of each year—after that year’s annual growth—equals its beginning balance for the next year.

Discussion:

I lied. Running the return sequence forward and backward is not just for fun. It is, in fact, a main point of this article. I want to demonstrate the surprising impact that the sequence of returns has on the entire 30-year strategy…

Here’s the return series. The table below shows:

  • Actual year.
  • Year number in the Growths’ retirement. The 10-year series will be repeated to total 30 years. The series will be run both forward (Trial 1) and backward (Trial 2).
  • The actual total returns including dividends of the S&P 500 (according to MoneyChimp) in 2000-2009, rounded to the nearest whole percent.
  • Model A: Volatility cut down to 2/3 of what it actually was.
  • Model B: Five percent added to each year’s returns.
Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Year# 1 2 3 4 5 6 7 8 9 10
Actual -9% -12 -22 29 11 5 16 6 -37 27
A -6% -8 -15 19 7 3 11 4 -25 18
B -4% -7 -17 34 16 10 16 11 -32 32

 

This will give us four shots at a successful 30-year retirement for the Growths: 1A, 2A, 1B, and 2B. Do you think any of them will work? Here are the trials:

  • 1A: Years run forward; volatility dampened to 2/3 of actual.
  • 2A: Years run backward, volatility same as 1A
  • 1B:Years run forward; returns 5% better than S&P 500.
  • 2B: Years run backward; returns same as in 1B.

Run 1A: Sequence Run Forward and Volatility Dampened to 2/3 of S&P 500’s Volatility

First Decade:

Year Number BeginningBalance $ Amount Withdrawn $ Amount Remaining $ Annual Return % End Balance $
1 1,000,000 40,000 960,000 -6 902,400
2 902,400 41,200 861,200 -8 792,304
3 792,304 42,436 749,868 -15 637,388
4 637,388 43,709 593,679 19 706,478
5 706,478 45,020 661,458 7 707,760
6 707.760 46,371 661,389 3 681,230
7 681,230 47,762 633,468 11 703,150
8 703,150 49,195 653,955 4 680,113
9 680,113 50,671 629,442 -25 472,082
10 472,082 52,191 419,891 18 495,471

 

Second Decade:

11 495,471 53,757 441,714 -6 415,211
12 415,211 55,370 359,841 -8 331,054
13 331,054 57,031 274,023 -15 232,919
14 232,919 58,742 174,177 19 207,271
15 207,271 60,504 146,767 7 157,041
16 157,041 62,319 94,722 3 97,563
17 97,563 64,189 33,374 11 37,045
18 37,045 66,115 (29,609) 0 0
19 0 0 0 0 0
20 0 0 0 0 0

 

Third Decade:

There is no third decade. The Growth Retirees ran out of money in Year 18 of their planned 30-year retirement.

Run 2A: Sequence Run Backward and Volatility Dampened to 2/3 of S&P 500’s Volatility

First Decade:

Year Number BeginningBalance $ Amount Withdrawn $ Amount Remaining $ Annual Return % End Balance $
1 1,000,000 40,000 960,000 18 1,132,800
2 1,132,800 41,200 1,091,600 -25 818,700
3 818,700 42,436 776,254 4 807,315
4 807,315 43,709 763,606 11 847,602
5 847,602 45,020 802,582 3 826,660
6 826,660 46,371 780289 7 834,909
7 834,909 47,762 787,147 19 936,705
8 936,705 49,195 887,510 -15 754,383
9 754,383 50,671 703,712 -8 647,415
10 647,415 52,191 595,224 -6 559,511

 

Second Decade:

11 559,511 53,757 505,754 18 596,790
12 596,790 55,370 540949 -25 405,711
13 405,711 57,031 348,680 4 362,628
14 362,628 58,742 303,886 11 337,313
15 337,313 60,504 276,809 3 285,113
16 285,113 62,319 222,794 7 238,390
17 238,390 64,189 174,201 19 207,299
18 207,299 66,115 141,184 -15 120,006
19 120,006 68,098 51,908 -8 47,755
20 47,755 70,141 (22,386) 0 0

 

Third Decade:

Once again, there is no third decade. The Growth Retirees ran out of money in Year 20 of their planned 30-year retirement. The resequencing of returns did get them an extra two years.

Run 2A: Sequence Run Forward and Returns 5% Better than S&P 500 Every Year

First Decade:

Year Number BeginningBalance $ Amount Withdrawn $ Amount Remaining $ Annual Return % End Balance $
1 1,000,000 40,000 960,000 -4 921,600
2 921,600 41,200 880,400 -7 818,772
3 818,772 42,436 776,336 -17 644,359
4 644,359 43,709 600,650 34 804,871
5 804,871 45,020 759,851 16 881,427
6 881,427 46,371 835,056 10 918,562
7 918,562 47,762 870,800 16 1,010,127
8 1,010,127 49,195 960,932 11 1,066,635
9 1,066,635 50,671 1,015,964 -32 690,856
10 690,857 52,191 638,665 32 843,037

 

Second Decade:

11 843,037 53,757 789,280 -4 757,709
12 757,709 55,370 702,339 -7 653,175
13 653,175 57,031 596,144 -17 494,800
14 494,800 58,742 436,058 34 584,317
15 584,317 60,504 523,813 16 607,623
16 607,623 62,319 545,303 10 599,835
17 599,835 64,189 535,646 16 621,349
18 621,349 66,115 555,234 11 616,310
19 616,310 68,098 548,212 -32 372,784
20 372,784 70,141 302,643 32 399,489

 

Third Decade:

21 399,489 72,245 327,244 -4 314,154
22 314,154 74,413 239,741 -7 222,959
23 222,959 76,645 146,314 -17 121,441
24 121,441 78,944 42,497 34 56,946
25 56,946 81,312 (24,366) 0 0
26 0 0 0 0 0
27 0 0 0 0 0
28 0 0 0 0 0
29 0 0 0 0 0
30 0 0 0 0 0

 

Once again, this withdrawal scheme fails, this time in Year 25.

Run 2B: Sequence Run Backward and Annual Returns 5% Better than S&P 500

First Decade:

Year Number BeginningBalance $ Amount Withdrawn $ Amount Remaining $ Annual Return % End Balance $
1 1,000,000 40,000 960,000 32 1,267,200
2 1,267,200 41,200 1,226,000 -32 833,680
3 833,680 42,436 791,244 11 878,281
4 878,281 43,709 834,572 16 968,103
5 968,103 45,020 923,083 10 1,015,392
6 1,015,392 46,371 969,021 16 1,124,064
7 1,124,064 47,762 1,076,302 34 1,442,244
8 1,442,244 49,195 1,393.049 -17 1,156,231
9 1,156,231 50,671 1,105,560 -7 1,028,171
10 1,028,171 52,191 975,980 -4 936,941

 

Second Decade:

11 936,941 53,757 883,184 32 1,165,802
12 1,165,802 55,370 1,110,432 -32 755,094
13 755,094 57,031 698,063 11 774,850
14 774,850 58,742 716,108 16 830,685
15 830,685 60,504 770,181 10 847,199
16 847,199 62,319 784,880 16 910,461
17 910,461 64,189 846,272 34 1,134,005
18 1,134,005 66,115 1,067,890 -17 886,349
19 886,349 68,098 818,251 -7 760,973
20 760,973 70,141 690,832 -4 663,199

 

Third Decade:

21 663,199 72,245 590,954 32 780,059
22 780,059 74,413 705,646 -32 479,839
23 479,839 76,645 403,194 11 447,546
24 447,546 78,944 368,602 16 427,578
25 427,578 81,312 346,266 10 380,893
26 380,893 83,751 297,142 16 344,684
27 344,684 86,264 258,420 34 346,283
28 346,283 88,852 257,431 -17 213,668
29 213,668 91,517 122,151 -7 113,600
30 113,600 94,264 19,336 -4 18,563

 

Finally, a Total Return plan that squeaks through, barely. If taxes were counted, this would have failed too. It will fail in Year 31.

More Discussion:

As with the previous article, I had no preconceived notions of how any trial would end up. I simply wanted to illustrate the importance of return sequencing on total returns. I was aware that using 2000-2009 as a starting decade would provide a severe stress test on the 4% strategy. That’s what a stress test should do.

[While] sequencing by itself [does not] make a difference in compounded returns…sequencing [is] important when you are making withdrawals because the withdrawals go relentlessly up (the result of the 3% annual increment), and sometimes an increased withdrawal coincides with a particularly bad annual return year. The combination can be lethal. In each run, the backwards sequence did better than the forward sequence. That’s because the smallest withdrawals coincide with the best returns in each decade when you run the sequence backward.

Here are some other takeaways:

  • If you have the misfortune to retire in a flat market, it is really hard to make the 4% rule work for 30 years. The likelihood that your portfolio will outperform the S&P 500 by 5% every year for 30 straight years is practically nil. Yet that’s what it took here to get a single successful trial.
  • In the lost decade of 2000-2009, the arithmetic average of each year’s returns was actually positive – but the compound average was negative. As some people say, down years have more impact than up years. The most common example of this is that returns of -50% and +100% do not yield +25% as their arithmetic average would suggest. They actually leave you at 0%, right where you started.
  • Getting off to a bad start in a withdrawal plan can cause psychological problems. In Run 1A, the portfolio was down more than 1/3 after the first three years. I imagine that can cause sleepless nights when you know that the portfolio is supposed to last for 30 years.
  • When portfolios are failing, their plunge to zero is sickeningly fast and steep in the last few years.

Conclusion

For me personally, this is my takeaway:

  • don’t rely on a total return strategy and portfolio withdrawals to fund retirement.
  • don’t employ automatic inflation escalators in your withdrawals every year.

How this method has gained dominance in the retirement industry is a mystery to me. The risks of failure, and fear of failure, are just so great.

Links to Related Articles by Van Knapp as Posted at Seeking Alpha:

  1. Retirement’s 4% Rule: Surprising Answers You Need to Know about the Inflation Factor
  2. *Retirement’s 4% Rule: The Importance of Return Sequence
  3. Retirement’s 4% Rule: Why Mr. & Mrs. Income Don’t Need It (Part 1)
  4. Retirement’s 4% Rule: Why Mr. & Mrs. Income Don’t Need It (Part 2)

 

 

2 comments

  1. If some one had one million on your retirement account, he or she is not bother to read this kind of information .
    I worked for small company more than 30 years, retired I have less than 50 grands in my saving, house almost paid off. And barely make it . Don’t know any body have this kind of money. Please be more realistic

  2. Whole exercise is a waste of time! My father died in 1988 of kidney failure. He died with $67 in the bank but he taught me a valuable lesson. You don’t really need that much money to retire. He was on a disability pension of $800 a month. He was receiving kidney dialysis treatments and on a bunch of different meds and his monthly rent was $650 a month. He received SSI payments of about $200 a month. The point is he did not have any money. He barely got by for 4 years with the small help we could provide but he was loved and he was happy.