Let me give a simple example using some round numbers just to show the concept. Plug and play any numbers you want to see how the outcome changes...
Let’s say you have a million dollars in March of 2000, you just retired, and you need to pull out $100,000 to live on. So, in April, you take out $100,000 and now you have $900,000. So you ended up taking out 10% of your principal.
However, the market is falling, and will drop 10% over the next year. So you now have $810,000, and you take out this year’s $100,000 which leaves you with $710,000. Effectively, you took out over 12% of your principal.
2002 is no better, and the market falls a further 13%, and is now down to $618,000. You take out $100,000 for this year’s expenses, leaving you with $518,000.
The next year is even worse in the market, and your nest egg falls 23%, which means you now only have $399,000 left. You still take out your $100,000 and are left with only $299,000.
Thankfully, the next year the market rises 26%. Hallelujah, your nest egg grew to $376,000. However, you still need to take out your $100,000, leaving you with only $276,000. You think your luck has turned around...
The next year the market rises, but only 9%, so your nest egg grows, but only to $301,000. You take out your $100,000, leaving you with only $201,000. Hmmmmm...
The next year the market rises again, but barely - only 3%, so your nest egg is now $207,000. You take out your $100,000 again, and only have $107,000 left. Uhhhh...
Thankfully, the market moves up 14%, and your $107,000 grows to $122,000. You take out your $100,000, leaving you with only $22,000 left.
Finally, in the last year, the market rises 4%, so your nest egg grows to $23,000. You withdraw all of it, and are now broke.
This effect is based on real numbers (rounded) from [0], and represent the S&P 500 market returns starting in the year 2000 (aka, the dot com bust). What happened to this poor retiree is called “sequence of returns”, and it is something that any good financial planner uses to test the durability of his or her projections.
- This person likely could have drawn social security income, given that it's 2000 and SSI is not bankrupt.
- Ideally you have the funds you need to retire in the principal alone, and are only relying on very modest growth rate to fight inflation once you're actually withdrawing from it.
- You shouldn't be withdrawing retirement funds from an S&P 500 index fund investment. The funds should have been in a retirement income-focused fund or low-risk bonds, which would have helped maintain principal even in down years.
- Ideally your house is paid off, so you're not paying down a mortgage, and have significant equity in your home to draw from as a last resort.
I think a more realistic scenario is someone in their mid-50s who thought the numbers were working out in their favor to retire early, only for the market to crash, and now that is no longer looking like an option.
I'm not addressing strategy, just the math to show sequence of returns does impact withdrawals.
Also, while I agree with you position, most people unfortunately are not in that kind of situation (of course, they typically don't have the $1M I used in my example either).
Let me give a simple example using some round numbers just to show the concept. Plug and play any numbers you want to see how the outcome changes...
Let’s say you have a million dollars in March of 2000, you just retired, and you need to pull out $100,000 to live on. So, in April, you take out $100,000 and now you have $900,000. So you ended up taking out 10% of your principal.
However, the market is falling, and will drop 10% over the next year. So you now have $810,000, and you take out this year’s $100,000 which leaves you with $710,000. Effectively, you took out over 12% of your principal.
2002 is no better, and the market falls a further 13%, and is now down to $618,000. You take out $100,000 for this year’s expenses, leaving you with $518,000.
The next year is even worse in the market, and your nest egg falls 23%, which means you now only have $399,000 left. You still take out your $100,000 and are left with only $299,000.
Thankfully, the next year the market rises 26%. Hallelujah, your nest egg grew to $376,000. However, you still need to take out your $100,000, leaving you with only $276,000. You think your luck has turned around...
The next year the market rises, but only 9%, so your nest egg grows, but only to $301,000. You take out your $100,000, leaving you with only $201,000. Hmmmmm...
The next year the market rises again, but barely - only 3%, so your nest egg is now $207,000. You take out your $100,000 again, and only have $107,000 left. Uhhhh...
Thankfully, the market moves up 14%, and your $107,000 grows to $122,000. You take out your $100,000, leaving you with only $22,000 left.
Finally, in the last year, the market rises 4%, so your nest egg grows to $23,000. You withdraw all of it, and are now broke.
This effect is based on real numbers (rounded) from [0], and represent the S&P 500 market returns starting in the year 2000 (aka, the dot com bust). What happened to this poor retiree is called “sequence of returns”, and it is something that any good financial planner uses to test the durability of his or her projections.
[0] - https://www.macrotrends.net/2526/sp-500-historical-annual-re...