When it comes to the long-term viability of the markets, I’m not worried. Most of us have lived through at least one or two historic market disruptions and that experience informs us. But the nation’s health experts continue to stretch the timeline of how soon the nation will begin to function normally. If we want to stay invested in the long term, that might mean tightening our belts. I’ll explain why.
Let’s say you have been taking out $5,000 per year from your $100,000 portfolio. Over the past decade, a five percent withdrawal rate was conservative. If your portfolio performed in line with the S&P 5001, then, until recently, you were probably ahead of the game. The market gains more than offset your withdrawals. But now let’s imagine your portfolio declined by 30%. Your withdrawal rate has increased from 5% per year to 7.1%.
When the market declines and you take out the same amount of money, you are selling more shares to maintain those withdrawals. It will be that much harder for your portfolio to recover from a decline. As you may have noticed while the market was trending up, short declines didn’t have much impact on your portfolio. But once those declines start persisting, they can take a heavy toll. I’ve seen that happen before. If I can prevent anyone from going through that or even reduce that damage, I’ll be happier.
Financial planners can illustrate the potential impact of withdrawing money in a declining market by running hundreds or even thousands of simulations of market movement and how those movements will impact your investments. That will leave you with estimates of how likely a certain withdrawal rate will be successful. If you have a full-service adviser, ask for a Monte Carlo simulation.
Regardless of the details, the less money you withdraw when the market is down, the more of a chance you’re giving your portfolio to recover. I understand this may be challenging if you’ve built your lifestyle around a higher expected cash flow than what your portfolio might be capable of generating now. Still, whatever you can pare down now will eventually make a noticeable difference.
Luckily, the government understands this and is stepping up with stimulus programs that may help keep the lights on. Since few people are going out, our travel and entertainment expenses should be lower. I understand that layoffs, furloughs and lower revenue will force many of us to move from our investments than we could ever have expected. The damage isn’t confined to the markets; it’s affecting the global economy. But if possible, keep slimming down those outlays. You’ll want to be in the market when the tide turns.
. 1The S&P 500 is an index of 500 major, large-cap U.S. corporations. You cannot invest directly in an index.