Are You Taking Too Much From Your Retirement Portfolio Too Soon?

Written by John Macy, Financial Coach, MBA, Retirement Income Certified Professional® (RICP)

One of the biggest risks in retirement isn’t market volatility — it’s withdrawing too much, too fast, especially in a down market. Once that nest egg starts shrinking, it’s tough to rebuild.  In combination with sharp market downturns it can be deadly.

What is "Sequence of Return Risk"?

First, let's define "Sequence of Return Risk" and when is it most dangerous to retirees? The concept of risk created solely by the sequence of returns experienced by investors was initially introduced and proven by financial planner William Bengen in a paper he published in October 1994 in the Journal of Financial Planning entitled "Determining Withdrawal Rates Using Historical Data". This is the same paper in which he articulated what has become known as the "4% Rule". Bengen proved that the average return experienced by an investor is completely irrelevant once they begin making ongoing portfolio withdrawals. In addition to the withdrawal rate, the sequence or chronological order of those portfolio returns is one of the primary determinants of whether a nest egg survives or whether that investor runs out of money.

Definition: As it relates to a retiree, "Sequence of Return Risk" is the risk that a significant market downturn (20% or more) occurs in the early years of retirement, forcing the retiree to sell assets at a loss to withdraw income. This can permanently deplete a portfolio and reduce its ability to recover from the decline. "Sequence of Return Risk" can also affect retirees if severe downturns occur right before they retire, dramatically reducing their nest eggs right when they need to start withdrawing.

What is the danger period? Financial researchers and advisors typically define the critical danger period as 5 years or so leading up to retirement and 5-10 years after retirement. Downturns that happen early in a career or later in retirement typically are much less dangerous to a retiree's financial health.

Are Any of these "Red Flags" True for You?

Here are a few red flags that you might be taking out more than your portfolio can comfortably handle:

🚩 Your withdrawal rate is consistently above 6% per year.

That might be sustainable for a few years (e.g., as an income bridge before you start taking Social Security), but over decades? It can drain your savings faster than you think—especially if markets take a dip early in retirement. While the "4% Rule" is the most commonly used rule for determining safe withdrawals from a portfolio, various flexible spending strategies (such as the Guyton-Klinger Guardrails Strategy) can enable higher safe long-term withdrawals (between 5% and 6%) as long as the retiree is willing to be flexible and adjust his/her withdrawals based on portfolio performance.

🚩 You’re selling substantial investments during significant market downturns to fund expenses.

That can lock in losses and reduce future growth potential—something known as “sequence of returns risk.”

🚩 Your portfolio balance is trending down year after year, even in decent markets.

If your portfolio balance is declining by more than 3.0-3.5% per year (on average) that’s a clear sign your withdrawals may not be in sync with your portfolio’s earning power.

🚩 You haven’t revisited your budget or income plan in a few years.

Over time inflation, healthcare costs, and lifestyle changes can all shift the balance between what’s sustainable and what’s risky. It is important to revisit your assumptions, your budget, and your income plan every few years to ensure that they are still reasonable given current and projected conditions.

Withdrawal Rate Safety

Withdrawal Rate	Risk Level	Context
3.0% - 3.5%	Very Safe	Ideal for early retirement or legacy planning
4.0% - 5.0%	Typically Safe (Baseline)	The commonly-used "4% Rule" range for a 30-year retirement
5.0% - 6.0%	Typically Safe (if have spending flexibility)	Flexible spending strategies such as the Guardrails Strategy
Above 6.0%	High Risk (unless only for short period such as before SS)	Potentially dangerous "Red Flag" for long-term sustainability

The good news?  A few smart adjustments can help your money last as long as you do and prevent a lot of stress.

The Solution: Steps to Building a Resilient Income Plan

The key is flexibility and guardrails, combined with smart budgeting and savings.

A robust retirement plan uses smart budgeting, smart savings, and smart adjustments to ensure your money lasts.  Implement some combination of the following ideas:

1. Create a Budget:  Create a realistic budget, track your spending regularly, and revisit the budget each year.

   
   

2. Build an Emergency Fund:  An emergency fund of about 6-12 months of expenses (excluding guaranteed income from Social Security, pensions, and annuities) can help you to cover short-term emergencies (like a car repair or replacing an appliance) without having to dip into your portfolio during market downturns. These funds can be invested in a high-yield savings account, money market fund, CDs, or short-term Treasury Bills to earn some interest on the money while keeping it safe from market turmoil.

   
   

3. Build a Major Asset Replacement “Sinking Fund”:  Build up a separate cash balance to fund the periodic replacement of cars, new roof, or new HVAC system for your house, large vacations, etc.  For instance, you might want to set aside money to replace each car every 5-6 years, to replace the HVAC system every 15 years, and to replace the roof every 20 years.  When the inevitable happens, you won’t have to dig deep into your portfolio to fund those major asset purchases. Like your emergency fund, these funds should be set aside in something safe such as a high-yield savings account, money market fund, CDs, or short-term Treasury Bills.  An alternative to this is to use a home equity line of credit to fund these purchases, but it is better to save up for these major expenditures in advance.

   
   

4. Maintain a 4-5% Withdrawal Rate:  In most years, keep your portfolio withdrawal rate between 4-5%.  That has been demonstrated to be a fairly safe withdrawal rate for a retirement lasting 30 years, even through periods of extended market turmoil or high inflation.

   
   

5. Build an Income Floor:  Use stable, guaranteed income sources (Social Security, pensions, and/or annuities) to cover 100% of your fixed, essential expenses (housing, healthcare, food). See this article for more information on how to build a retirement income floor.

   
   

6. Flex Your Spending:  If you have a guaranteed income floor covering your fixed essential expenses, your investment portfolio can be confidently used for your optional, discretionary spending (travel, hobbies). You can then flex this spending up in good market years and down in bad ones (such as using the Guardrails Strategy). This simple adjustment dramatically improves sustainability.

Don't wait for the warning signs to appear. If you're unsure whether your current withdrawal rate is sustainable, it's time for a professional portfolio "stress test.”  A little planning now can prevent a lot of stress later. For insight into how large your portfolio needs to be to confidently step into retirement, see this blog post on "How Much Money Do You Need to Retire?"

If you would like a friendly, expert assessment of your portfolio withdrawal strategy or help in designing a plan contact me or visit www.flourishingpathfinancial.com/book-online to book a free Discovery Session.

Author:  John Macy, MBA, RICP®

John Macy is a professional financial coach and the founder of FlourishingPath Financial Coaching. With over six years of experience as a financial coach, John helps pre-retirees and retirees design resilient portfolios and income streams for their next act. Read his full story here.