Can You Do Everything Right and Still Run Out of Money?

The answer is yes.

With one important clarification.

You probably can't literally do everything right and run out of money.

But you can do everything traditional retirement planning has taught you to do—and still run out of money.

Or, more importantly:

Run out of income.

That's because something changes dramatically on the day you retire.

For 30 or 40 years, you've been filling the reservoir.

Then you retire.

And you turn on the pump.

Retirement Changes the Math

While you're working, you're generally putting money into your retirement accounts.

Your 401(k).

Your IRA.

Your investments.

Markets go up. Markets go down. But you're still contributing.

Then retirement begins.

Now you're taking money out.

Those withdrawals may be paying your mortgage, electric bill, groceries, vacations and everything else that used to be paid for by your paycheck.

Your investments may still grow.

Using the metaphor from the last article, it may still rain.

But now you're simultaneously draining the reservoir.

And that creates a risk many people approaching retirement have never been taught to think about.

It's called:

Sequence-of-returns risk.

The name sounds complicated.

The idea isn't.

Same Rain. Different Order.

Imagine two people retire with exactly the same amount of money.

They withdraw exactly the same income.

Their investments experience exactly the same returns.

And over time, they even earn exactly the same average rate of return.

You'd expect them to have approximately the same outcome.

Right?

Not necessarily.

Because in retirement, the order in which those returns happen can matter enormously.

Lots of rain during the first years of retirement?

That's good.

Major losses during those first years?

That can be devastating.

Same rain.

Different order.

Let me show you what I mean.

Meet Steve

Steve retires with:

$500,000.

Over the following years, his investment portfolio averages 8.25%.

That's a pretty respectable average return.

Steve also withdraws money every year to support his retirement.

And things work beautifully.

The strong returns happen relatively early.

His account grows while he's withdrawing from it.

Later, when some of the bad market years arrive, Steve has substantially more money in the account.

After 20 years, despite taking his retirement income along the way, Steve still has roughly:

$822,000.

That's a successful retirement outcome.

He may be able to continue his income.

Perhaps give himself raises.

Perhaps leave an inheritance.

Everything appears to have worked exactly as planned.

Now meet his friend Bill.

Bill Does Exactly the Same Thing

Bill also retires with:

$500,000.

Bill takes exactly the same income.

And Bill's portfolio experiences exactly the same investment returns.

In fact, Bill also averages:

8.25%.

Same starting balance.

Same withdrawals.

Same returns.

Same average return.

There's only one difference.

The returns happen in a different order.

Bill gets the bad years early.

And approximately 16 years into retirement:

Bill is broke.

The account reaches zero.

And because Bill was depending upon that account to provide his retirement paycheck, his income stops too.

Think about that.

Steve ends up with more than $800,000.

Bill ends up with nothing.

Yet they experienced the same investment returns.

How is that possible?

Withdrawals Change Everything

This is one of the biggest differences between investing while you're working and investing while you're retired.

Suppose the stock market crashes while you're 45 years old and still working.

That may not feel good.

But you're probably not selling investments every month to pay your electric bill.

In fact, if you're contributing to your 401(k), you're doing the opposite.

You're buying.

And you're buying investments at lower prices.

If the market eventually recovers, all of those investments you purchased at lower prices participate in that recovery.

Now imagine the same crash happens immediately after you retire.

You aren't contributing anymore.

You're withdrawing.

The market falls—and you still need your paycheck.

So you sell investments while they're down to pay the mortgage.

You sell some more to buy groceries.

More for the electric bill.

More for everything else.

Then the market eventually recovers.

But there's a problem.

You don't own as many investments anymore.

You sold some of them while prices were low.

They can't participate in the recovery because they're gone.

That's sequence-of-returns risk.

And that's how two retirees can experience the same average investment return and have dramatically different outcomes.

Hope for the Best. Plan for the Worst.

I believe in optimism.

I hope markets perform beautifully throughout your retirement.

I hope it rains.

But hope isn't a retirement income strategy.

Good planning asks another question:

What happens if it doesn't rain?

What if the market crashes shortly after you retire?

What if there's a prolonged downturn?

What if you live much longer than expected?

Can your retirement survive those events?

That's what I mean when I say:

Hope for the best. Plan for the worst.

That's not pessimism.

That's planning.

Can You Drought-Proof Your Retirement?

I think this is where retirement planning gets much more interesting.

What if every dollar didn't have to do the same job?

Instead of asking one portfolio to provide growth, liquidity, income and protection simultaneously, what if different portions of your money had different jobs?

Some money might be there for liquidity.

Some might be there for growth.

And some might have one very specific job:

Create income.

Income that doesn't require you to sell investments during a market crash just to pay your bills.

That's the idea behind drought-proofing the retirement paycheck.

You aren't trying to control the rain.

You can't.

You're changing how dependent your lifestyle is upon the rain arriving exactly when you need it.

Mindset. Method. Moves.

This is another example of the Retire NOW Method in action.

Mindset — See Clearly.

Average returns don't tell the whole story once you're withdrawing money.

Method — Find Options.

Your entire retirement portfolio doesn't necessarily have to operate the same way or perform the same job.

Moves — Make Tradeoffs.

You may decide to exchange some liquidity, upside potential or access to a portion of your capital in return for more predictable income.

That's a tradeoff.

And tradeoffs aren't automatically good or bad.

They're choices.

The question is whether a particular exchange helps you create the retirement you actually want.

The Goal Isn't to Predict the Market

Nobody knows exactly what the market will do during your first five years of retirement.

That's precisely the point.

You don't need to predict it.

Instead, ask:

What happens to my retirement if the prediction is wrong?

If your entire retirement plan depends upon selling variable investments every month—and you need favorable market performance during the early years—then sequence matters tremendously.

But if the income required to support your basic lifestyle is coming from sources designed specifically to provide income, the market can have a different job.

Now the growth portion of your portfolio may have more opportunity to recover because you aren't necessarily forced to sell it during the worst possible moment.

You're separating jobs.

Can You Do Everything Right and Still Run Out of Money?

If by "everything right" you mean:

Save diligently.

Build a portfolio.

Diversify among stocks, bonds and funds.

Earn a respectable average return.

Withdraw carefully.

Then yes.

You can still run out of money.

Steve and Bill show us why.

The question isn't merely:

What's my average return?

It's also:

What happens if the bad returns arrive first?

You can't control the rain.

You can't control the market.

You can't control the sequence.

But you can control how dependent your retirement paycheck is upon all three.

Maybe the answer isn't simply building a bigger reservoir.

Maybe part of the answer is digging a well.

And once you've created enough reliable income to support the life you want, you may discover something surprising:

Work may already be optional.