When you retire matters a lot more than you think

The starting year of retirement makes a huge difference in the success or failure of a retirement plan. This is the key difference between the accumulation phase of investing and the withdrawal phase of investing. Yet the majority of investing writing does not take this key difference into account when speaking of returns, asset allocation, planning, etc. So, lets look at how important the starting year of retirement is to a successful outcome and what potential a retiree can do to mitigate this risk.

Why does the starting year of retirement matter in the first place? It is because retirement involves yearly withdrawals from the portfolio. Once you start making yearly withdrawals from a portfolio the sequence of investment returns, the year by year order of those returns influences how much you can withdraw from that portfolio and have it last for the full retirement period. This is NOT the case pre-retirement where there are no yearly portfolio withdrawals. The figure below (from Gestaltu) shows three separate return paths to the same final total portfolio value.

Alternate return parths chart oct 2014

The blue line shows a constant return path. The red line shows an early bull market followed by a weak market and the green line shows an early bear market followed by a strong bull market. For an investor in wealth accumulation mode, all three return paths have the same result – the same end wealth. But that’s not the case for retirees. The blue line retiree enjoys a consistent retirement and in fact their safe withdrawal rate (SWR) can be set equal to the portfolio return. Unfortunately, the blue line return assumption does not exist. It never has. Annual returns are lumpy. There are some good years and some bad years. And it turns out the order of good vs bad years makes all the difference for retirees. In retirement literature this is called sequence of returns risk or path dependence in retirement. The red line retiree in the figure above can enjoy much higher withdrawals from their retirement portfolio than the green line retiree even though the returns over the entire period are exactly the same. Using the blue line return as the SWR, the blue line retiree would have a successful retirement. The red line retiree would have a wildly successful retirement and the green line retiree would run out of money. For a great case study of this particular scenario see here.

If the sequence of returns matter in retirement then how can we measure it’s impact? We can look at the correlation between time period returns and SWRs. As hinted at in the previous paragraph early returns are much more important than later returns. The chart below show this quite clearly. From Michael Kitces who has a great recent post on this topic.

SWR correlation by return time horizon oct 2014

Turns out that 10 year real returns have the highest correlation with SWRs. Also, notice that nominal returns don’t matter nearly as much as do real returns which makes sense since retirement is about keeping inflation adjusted spending consistent. 10 year real returns explain almost 85% of the SWR. This is where the attention should be focused – on the first 10 years of retirement. Now lets look at some specific retirees of the past to give you a feel for the impact of these numbers. See the table below.

Rolling 10 and 30yr 60 40 portfolio return history summary oct 2014

In the table I show the 60% stock/40% bond portfolio 10 year and 30 year period return figures for various years of starting retirement. The first two rows show the worst case retirement periods in history, the 30 year periods starting in 1966 and 1929. The 1966 period alone solely determines the historical SWR. See here for more on 1966. As the table shows, the 30 year period returns are pretty darn good even for the 1966 retiree. However, what really hurt the 1966 retiree was the first 10 years of retirement where their returns were negative on a real basis. The 1929 retiree despite the worst stock market decline in history experienced higher real returns than the 1966 retiree (even though nominal returns were lower). As they say, you can only eat inflation adjusted income. Just for kicks, now look at Mr and Mrs 1982. Wow! What a retirement. Simply, really, by luck of the draw of when they retired.

What does the future hold? For the 1999 retiree, the first 10 years have definitely not been great but they have not been as bad as the past. In fact it looks like the 1999 or the 2000 retiree are proceeding to a successful retirement (see here for the latest data). But it was dicey those first 10 years. And what about those who are considering retiring shortly? That is a whole other topic for a post but what needs to be considered is clear. Retirees need to consider what weak returns during the first 10 years of retirement can do to their portfolios and put plans in place accordingly. I’ve touched on this topic in other posts on various portfolio options and spending strategies that can improve the probability of a successful retirement. I’ll return to it again in future posts. There is much to say.


Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

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6 Responses to When you retire matters a lot more than you think

  1. Jeff Mattson says:

    Very interesting, it is nice seeing my portfolio grow and comforting that GTAA recently had a well-timed switch to more bonds as the market becomes more volatile. However, as I am within four years of retirement, perhaps I should hope for an inevitible crash now rather than later. Seems like the safest time to retire would be right after a crash, although I guess the 2001 retiree didn’t get 10 solid years.

    • libertatemamo says:

      Hi Jeff, unfortunately that strategy only works for buy and hold if you’re heavy cash or bonds before the crash. With the GTAA strategies, yes, a big crash now would do you good. You’d start from a cheaper equity valuation base – higher future expected returns come from low valuations, not high ones. The 2001 retiree is doing just fine with 60/40 B&H – first 10 year returns of 4.2% nominal, 1.6% real, and subsequently up from there.


  2. Ed H says:


    This, like all of your posts, has been very thoughtful, and thought-provoking! My wife and I are recent retirees in our early 50’s. We are generating our income from our investments (self-managed). Sequence of returns, flexibility of expenditures, income investing options, and diversification/asset allocation, are very high priority topics for me.

    To me, an underlying idea behind many of your posts is that a vast number of today’s recent, and soon-to-be retirees do not have traditional defined benefit retirement plans to generate their retirement income. Many will depend upon their own investment knowledge/skills –or- the advice of Financial Advisors to assist in generating their income from their 401(k) and other savings accounts. My discussions with different FA’s leads to me believe, that many are not discussing the important concepts that you have been discussing in this and prior posts.

    A couple of thoughts:

    1) I have found that discussions of SWR’s often do not include the positive impact of the dividends/distributions generated from the investments (i.e. income oriented investments like dividend growth stocks, MLPs, REITS, Utilities, etc). While many may need to withdraw more than just the income from their portfolios to cover their expenses, it seems to me that including the dividend/distribution income in the SWR models would show that many portfolios cover retirees for many more years, than is shown in typical SWR models. My guess is that this is partially explained by the orientation of the financial industry toward portfolio growth. Fund Managers, and FA’s are primarily judged on the total return of the portfolio with a strong orientation to the growth of the underlying assets/portfolio, as opposed to the level, consistency and growth of the income generated from the underlying investments. Your thoughts?

    2) Does this post have any implications for the timing of one’s retirement? I.e. (where there is flexibility) Should one’s retirement date be timed to correspond with the start or middle of an economic growth phase? And when the underlying capital markets are not over-valued?

    Thank you for your blog! Please keep the posts coming!

    As a side note: My wife and I have been following your wife’s blog for the past 3+ years. As recent full time RVers, we found her posts to be invaluable and very enjoyable to read!


    • libertatemamo says:


      Thanks for the comments and questions. You are correct that many FAs don’t discuss these topics with their clients. Many because of a lack of knowledge. But I do that changing a bit but it has a long way to go. Hopefully though posts like this clients will start pushing their FAs to consider these other metrics or find new FAs. I can only hope. On to your questions.

      1.) The SWRs do account for income. The models include income from bonds and dividends from stocks. The problem that your alluding to is that most models only include two assets classes, US stocks and 10 yr gov’t bonds that pay little in income compare to other options out there. So, income is accounted for in the models but not that much. Other assets with higher income would only help SWRs IF they also increase total returns. And some of those assets like corporate bonds, dividend payers, etc.. would accomplish this but its not because of the income they generate. However, I think the most important aspect of income investments is that it helps retirees stick with their asset allocations plans despite what the market is doing. And that is invaluable.

      2.) Maybe counter intuitively, No. The problem is with timing one’s retirement is that you’re usually invested pre-retirement so a big market drop is going to take your retirement assets down with it. So, despite the new improved lower valuation you have less assets to begin with. This is unless you have some asset allocation model that has a built in risk management plan like the models I discuss here on the blog.

      Nice to hear of some new RVers on the road. Maybe we’ll meet out there some day.


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