One of the main lessons I’ve learned from looking at various retirement withdrawal strategies is the importance of having a mechanism to protect a portfolio from bear markets.

This typically involves a level of flexibility. Flexibility can mean shifting the source of withdrawals, adjusting their size, tightening your budget or a combination of these approaches. The right strategy depends on your allocation, wealth, tolerance for volatility and desire for simplicity.

One approach is to incorporate a buffer. The buffer is a source of funds that you can tap into when the stock market is down. What constitutes a buffer depends on who you ask. It can be cash equivalents, a reverse mortgage or something else. The key is that the buffer asset is not correlated with stocks.

For this issue, I modeled a buffer withdrawal strategy using essentially the same allocation as a diversified portfolio that was either periodically rebalanced or never rebalanced. The buffer asset in this case was an intermediate bond fund. This fund allowed for an apples-to-apples comparison, though a real-world portfolio would likely use a short-term bond fund or a money market fund.

I first ran the test using a 60% stock/40% bond allocation—a common moderate allocation. Withdrawals were taken proportionately during most years based on each fund’s weighting. Whenever the S&P 500 index was down, withdrawals were taken solely from the bond fund. The bond allocation was then replenished over the next two years when the S&P 500 was up.

The strategy led to higher ending wealth for most 25-year rolling periods analyzed. Ending allocations to stocks were also higher.

When I switched to an aggressive allocation of 90% stocks and 10% bonds, the buffer strategy had higher ending wealth during the majority of the periods analyzed, but not all. The buffer strategy fared comparatively worse when the lost decade of 2000–2009 occurred during the first half of the modeled 25-year retirement period. You can see the full comparisons in this issue’s article, "Which Protects Your Retirement Better: Rebalancing or Buffer Strategies?"

I did not attempt to optimize the buffer strategy in order to keep the testing simple. Applying concepts from AAII founder James Cloonan’s Level3 withdrawal strategy—particularly waiting for the S&P 500 to fully rebound before replenishing the buffer asset—seemed to further improve the results of the buffer when I did some spot checking.

Cloonan’s Level3 withdrawal strategy is a type of buffer approach. It is designed to maximize growth of capital while setting aside enough in safe assets to avoid selling stocks during down markets. You will find an updated look at this strategy in this issue’s article, "Using the Level3 Withdrawal Strategy to Achieve Growth and Stability."

Late-in-Life Spending

Regardless of which withdrawal approach you choose, be aware of the potential for high later-in-life expenses. Medicare and health insurance will cover much (if not most) of your medical needs, but not your daily living needs.

These costs can be high depending on where you live and what your needs are. A large amount of my mother-in-law’s savings was spent on caretakers in her final months. This was in addition to the cost for her to live in an assisted living community and then memory care. Speaking from personal experience, do not expect an assisted living facility to provide all the personal assistance you or a loved one might need.

Long-term care insurance is intended to pay for some of these costs. Cynthia McLaughlin and I spoke to Howard Gleckman, a senior fellow at The Urban Institute, about what long-term care covers as well as common misperceptions about it. The interview, "Understanding the Role of Long-Term Care Insurance," is this month’s feature article.

Wishing you prosperity and good health,