Creating Your Retirement Paycheck (Part I) – It’s Not About Returns; It’s About Your Account Balance

One of the main questions people want to know as they approach retirement is "how am I going to get paid once I stop working?" Saving and accumulating wealth is much different than trying to figure out how to create a stream of income that's going to last for several decades and keep up with inflation. This is the first in a three-part series of articles designed to help you better understand how to create a Retirement Paycheck. These are the topics we'll cover:

  1. It's not about returns; it's about your account balance
  2. It's not how much you earn; it's how much you keep
  3. It's not about cash; it's about cash flow
It’s Not (Just) About Returns When we say it's not about returns, what we mean is that for someone nearing retirement, the average investment rate of return is only part of the story. The sequence of returns is tremendously important when you are drawing down from a portfolio. Below is an example of two $1 million portfolios with the same average return of 6% over a 25-year period. Assume the first one (in blue) is named Mr. Bull and the second one (in orange) is named Mr. Bear.

This is a hypothetical example and is not representative of any specific investment. Your results may vary.

Now, let’s look again at those portfolios but assume that Mr. Bull and Mr. Bear are each withdrawing money from them. Let’s assume they each withdraw 5% (or $50,000 per year) over that period. In that case, the results are dramatically different. Due only to the different sequence of returns, Mr. Bull has a portfolio that continues to grow in retirement, while Mr. Bear depletes his portfolio by his early 80’s.1

This is a hypothetical example and is not representative of any specific investment. Your results may vary.

A Different Kind of Math To understand why this happens, we need to understand a different kind of math. -25 + 33 = 0 When does negative 25 plus 33 equal zero? If you invest money and you lose 25% you need to earn more than 33% to get back to even. (see the illustration of this below) The math gets worse as you factor in withdrawals. Assuming the same 25% downturn, but then factoring in three years’ of withdrawals (of 5% or $50,000 per year), you would have to make up a 40% deficit (-25-5-5-5=-40). It would then require a 67% positive return to get back to even (as shown below). Be Prepared So what do you do about all of this? If you are twenty years away from retirement, you don’t need to worry about it much at all. But if you are only a few years or months away from retirement, that’s a much different story. Realize that we are in the midst of one of the longest bull markets in history. That means that you should be proactively preparing for a recession in order to stress test your wealth plan. At Brown and Company, we have created what we call our Recession Prep Scorecard™ to assess our clients’ preparedness for a potential downturn in the markets. If you are nearing retirement and have not done an assessment like this to ensure that you are prepared, just provide your information below and we will follow up with you to prepare a complementary scorecard for you. [gravityform id="1" title="false" description="false"] 1 Source: Baird Financial: http://www.bairdfinancialadvisor.com/chris.trumble/mediahandler/media/118612/Sequence%20of%20Returns%20Risk.pdf