The Wrong Way to Think About Your Retirement Portfolio

by: Roger Nusbaum

A comment came in yesterday about how long it might take to get back to even from this bear market. My hunch is that the market will retrace a big chunk of the decline from its bottom and then meander for a while - and yes, it could be a long time before the S&P 500 sees 1565 (not a prediction, more like something we should maybe brace for, and consider more foreign).

So here is a thought that might whip a few people up: How long it takes to get back to even is the wrong thing to think about.

The value of your portfolio today is what it is. It has either outperformed or lagged the market during this bear phase, but whatever the dollar amount - that is it. The day you start to draw income from it (or if you are taking income now) the value will be whatever it is. For someone drawing income now, the value a few years ago means nothing.

A 55 year old who wants to start taking an income in ten years will need to base that income on what he has then. If he has $800,000 ten years from now, then that is his reality. If three years before he draws money it was worth $650,000 or $950,000, he needs to base his withdrawal on $800,000 - not some high water mark from the past.

I think this circles back to my "whatever you got, 4%" rule about how much to take out every year. If you had $1 million one year, took out $40,000 and the portfolio lost 10% you now have $860,000 (simplistic math). If you take out the same $40,000 the next year and also had a 5% loss you now have $777,000 (again, simplistic math). Now $40,000 is more than a 5% drawdown, and the path to trouble is much easier to see.

Sticking to 4% (or more practically 1% of the value of your portfolio on the last day of the quarter) is problematic, because it means the income generated can fluctuate in such a way as to create a lot of uncertainty in the family budget. Obviously "whatever you got, 4%" is not perfect - but it beats running out of money.

I think it makes more sense to stick with a strategy of saving and maintaining the proper asset allocation, along with going on defense every now and then when market circumstances dictate. Right here right now is a little trickier. There is a balance to be struck between defense and not letting a massive rally that comes from nowhere that catches everyone by surprise happen without you.

My blog posts for the last couple of months have covered how I am trying to strike that balance, which is not easy. I would add that regardless of the fundamentals or whatever the bottom is or when it comes, after a greater than 40% decline, a massive rally that comes from nowhere and catches everyone by surprise would be far from a black swan.