Retirement Investing 101: Don’t Make This Common Retirement Investing Mistake

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In this video, I’m going to talk about one of the biggest retirement investing mistakes. I see this mistake all the time, and it’s a big one. It could mean the difference between a successful retirement or one where you end up running out of money.

Let’s get started.

For most of us there will be two primary phases to our investing life. The accumulation phase and the withdrawal phase. Both phases require a different investment strategy.

Accumulation Phase:

During the accumulation phase your main investment objective is usually to “have enough money to retire.” Your portfolio will generally be allocated to more of a growth strategy, and your time horizon is known. If you are systematically saving money on a regular basis, such as through your 401k, market declines may actually work to your advantage. Dollar cost averaging, as its commonly referred to, allows you to buy more shares of your stocks and funds when the market is down, and fewer shares when the market is up.

Now let’s look at the Withdrawal Phase:

The withdrawal phase is a lot trickier. Planning for your distributions to last you for the rest of your life requires a lot of thought. During this phase your main investment objective is to “not run out of money”. Your asset allocation needs to be set up to accommodate the anticipated withdrawals you will need to take from your portfolio. Our time horizon is unknown, and here, market declines work against you. If you take a withdrawal when the market is down, you will forever lock in those losses. This is sometimes referred to as reverse dollar cost averaging.

During the accumulation phase, the average of your returns are what matter, however, during the withdrawal phase, the sequence of your returns may be more important.

Here’s an example.

Bob retires in 1991 and invests $1,000,000 in the S&P 500. Because he needs money to supplement his retirement income, he decides to withdrawal 6% or $60,000 a year. He plans to increase it each year by 3% to keep up with inflation. So how did he do?

Well over the next 20 years he withdrew a total of $1,612,222 and his portfolio grew to $2,930,862. Not bad. He put in $1 million, took out $1.6 million and his account balance still nearly tripled.

Over that 20 year time period the S&P 500 averaged 11% a year. But, what do we know about that time? Well the 90′s were one of the best decades for the market and the first decade of the 2000′s were one of the worst. Basically we had a really good decade followed by a really bad decade. But what if it were reversed? What if we get the bad years early in retirement?

Lets take a look. Here we used the exact same example with one simple change. We reversed the order of the returns. So instead of 1991 being the first year it’s now the last year. And instead of 2009 being the last year, it’s now the first. Of course it doesn’t matter how we scramble up these returns the average is always going to be the same. 11% per year.

How did Bob do?

Bob invested the same $1 million, still took out $1.6 million, but instead of having nearly $3 million at the end of 20 years, he now is down to just over $200,000. Not out of money yet. But with a few more withdrawals he probably will be.

So, the average of your returns may not be as important as the sequence of those returns. Primarily, if you get more bad years at the beginning of your retirement it can have a very negative affect that can be difficult to recover from. On the other hand if those bad years come after a series of good years, it tends not to have as big of an impact.

So one of the biggest retirement income mistakes is continuing to use an accumulation strategy after they reach the retirement withdrawal phase. Unfortunately this happens all the time. In the 80’s and 90’s people got away with it. Interest rates were high, and the market had one of the best 20 year runs in history. Now since then, interest rates are near all time lows, and the stock market has had two major crashes since 2000. If you want to increase your chances that your money will last for the rest of your life, Don’t use the same strategy for withdrawals as you did during your accumulation phase.

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