As part of our tradition of wishing each other a Happy New Year I was speaking to a good friend who likes math about her parents’ investments. The couple has been investing over the past forty years and with that money along with the sale of the successful family business they have amassed about $5M. They have always enjoyed traveling all over the world, so the way they roll in full retirement requires about $200,000 annual income. With the application of the 4% annual withdrawal rule the couple with their $5m could count on the kind of income with which they have become accustomed.
My friend described how she was afraid that her parents were overly confident they could weather a severe market decline because they had been through two -50% declines in the past. But that was when they were working and contributing. It’s a whole new ball game when investors are trying to avoid running out of money before they run of time in the next forty years. Financial advisors are known for extolling the virtues of buy and hold, sticking to stocks for the long haul, and owning inexpensive investment vehicles.
But different strategies are appropriate at different times. When investors are adding to their positions consistently a buy and hold strategy can be your friend. However, when the same investor needs income, the buy and hold strategy may become your foe when you are taking withdrawals. As you can see in the chart below with $5m, the withdrawal in the first year is $200,000 or 4% at the same time that the drawdown or market loss is -56%, which leaves the end of the year balance at $2m. On the far right is the withdrawal rate, noting in the second year to maintain the same lifestyle the withdrawal speed limit jumps from 4% to 10%. In the ten year period assuming no cost of living adjustments from 2008 to 2017 or rising mandatory distributions from traditional retirement accounts, for example, by spending the static $200,000 the withdrawal rate ranges from over 7% to nearly 9% a year despite market gains over time. The odds of getting back to opening balance may not be in your favor.
Source: Investor’s Advantage Corp.
It seems to me that three of the characteristics of affluent investors include they aren’t afraid of math, they embrace deferred gratification, and they hate losses more than they love gains. Now imagine how this story will change dramatically if there was another -50% loss in the now retired couple’s future.
You may have heard President Donald Trump say to reporters after the Dow hit 25,000, “I guess our new number is 30,000.” On January 23, 2018, US News & World Report put it this way, “For some historical perspective, the Dow Jones Industrial Average first hit 10,000 in March 1999, which was considered rather mind-blowing back then, and just a couple of months later it reached 11,000. That was a 10 percent gain. But moving from 24,000 to 25,000 represents only a 4.16 increase. And if the Dow ever goes from 29,000 to 30,000, that 1,000-point gain would represent only a 3.4 percent gain.”
3 Things to do now:
- What did you learn from 2008-09? How low did your account go? How long did it take to get back to even? Was it about four years? Could you have fully recovered in less time?
- Don’t just assume you can weather the next storm, do the math. Discover your market loss threshold. Determine now how much loss you can accept without having an anxiety attack.
- Think ‘Wax on, wax off’ from the movie Karate Kid. To limit market loss participation identify the teams and their strategies that moved from risk assets (wax off) into cash or alternatives in 2008 and moved from safe positions back to stocks and bonds (wax on) in 2009.
When disaster strikes there is no time to plan. If the loss is too severe there may not be enough time to recover.
The proof is in the planning®
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