Some call it the “fragile decade,” that first 10 years of retirement when market movements can have a profound effect on a portfolio’s ability to sustain income and financial security for the years ahead.  It has a lot to do with the sequencing of returns.

In the years leading up to retirement, many investors have discretionary income to make meaningful contributions to retirement savings, and they’re not yet drawing from those nest eggs.  If markets are down, they’re buying in at lower prices with better upside prospects ahead.  But once that employment income must be replaced, at least in part, by withdrawals from retirement savings, the impact of a significant market downturn can be magnified.

Suppose one starts retirement with a diversified, million-dollar portfolio and initiates 4% annual withdrawals.  If in the first year of retirement the portfolio suffers a 10% market-driven decline, and then a 5% decline in year two, those withdrawals will trim that $1,000,000 portfolio down to about $780,000.

At that level, $40,000 represents a more aggressive 5.1% withdrawal rate. Even a 15% bounce-back performance for the underlying investment holdings in year three will only restore the portfolio to about $850,000 net of those ongoing withdrawals.

Sustainability of Income

For a Portfolio

Diversified as Follows:        At a withdrawal rates of:

24% U.S. Stocks                      3%       4%      5%      6%

24% Internat’l Stocks               Chances of sustaining

24% U.S. Bonds                       income for 30+ years is…

20% Global Bonds                   95%      95%     92%     69%

5% Cash

Asset class indexes: Cash: 90-Day U.S. Treasury; U.S. Stocks:

S&P 500 Index; U.S. Bonds: Ibboston U.S. Long-Term Corp.

Bond Index; Internat’l Stocks: MSCI EAFE Index2; Global

Bonds: Citigroup World Government Bond Index

Source: Franklin Templeton Investments

The foregoing is hardly a disaster scenario.  Yet the odds of a diversified portfolio supporting that $40,000 annual withdrawal have dropped a few percentage points, as indicated in the accompanying table. If the decline is severe enough to make that $40,000 a 6% distribution rate, the 30-year sustainability odds drop all the way to 69%.

Fortunately there are strategies to guard against an unlucky sequence of returns in the fragile decade.  That’s a discussion to be had and regularly revisited with your investment professional.