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Retirement investors must balance two fundamental risks—the risk of not having enough growth in their portfolios to sustain income for many years in retirement versus the risk of a steep market decline that could substantially cut into assets at the worst time, such as retiring during a bear market.

Prior T. Rowe Price studies have noted that a lower equity exposure in a retirement portfolio has helped protect against short-term market setbacks, but provided less retirement income over the long run. A new analysis shows that even those who pursue a more conservative investment strategy to avoid large losses at retirement—with the intention of cashing out their assets soon after retiring to, say, buy an annuity—might not do as well as those with a more aggressive strategy. This was the case even for some risk-averse retirees who started withdrawing their retirement savings on the eve of the 2008 market crash.

The reason: Even with a sharp downturn in stocks at retirement, an investor who had a high allocation to equities for many years prior to retirement had the opportunity to accumulate more assets than an investor who had pursued a more conservative allocation. In other words, though many investors naturally focused on their losses in the 2008 market crash, those who had a sufficient exposure to stocks for years leading up to the crash may still have ended up better off than investors who had been much more conservatively invested all along.

Two Strategies for Retirement

The new T. Rowe Price study compared the outcomes for two hypothetical investors who each retired at the end of 2007 and planned to withdraw all of their savings in three installments: one-third in January 2008, one-third in January 2009, and one-third in January 2010. It then examined which of these investors would have been able to withdraw more savings if one had been invested with less equities and the other invested with higher equity exposure.

As shown in Figure 1, the higher-equity investor begins with a 90% allocation to stocks 30 years prior to retirement (which is assumed to start at age 65). His allocation is reduced by 1.32 percentage points a year for the next 30 years, so he has 50% of his portfolio in stocks at age 65. After retiring, the allocation to stocks is reduced one percentage point a year after that so the investor has 20% in equities at age 95.

Having experienced a good deal of such volatility the past few years, many investors who are about to retire—and particularly those who plan to withdraw their retirement savings soon after retiring—might find the idea of less market risk from less equity exposure more appealing. Indeed, the study shows that if the two investors each retired at the end of 2007 with $1 million retirement nest eggs and planned to withdraw their respective savings in three equal annual installments, the total withdrawals of the less-aggressive investor would have been more than that of the more-aggressive one: $1,002,680, versus $919,970.The more conservative investor—the one with a lower equity exposure—also begins with a 90% allocation to stocks 30 years prior to retirement (which is assumed to begin at age 65). His exposure to stocks is reduced by 2.32 percentage points a year, so that the stock allocation is 20% at retirement. His allocation to stocks then remains at that level to age 95. In contrast to focusing on the risks of inflation and longevity, this investor is focused on reducing the risks from short-term market volatility.

This result should not be surprising, as the portfolio with the higher equity allocation encountered greater short-term volatility. Over 2008 and 2009, this portfolio with greater equity exposure lost 4%—including a decline of 17.3% in the 2008 bear market. In contrast, the lower-equity portfolio gained 5.5% over the two-year period.

Impact of Long-Term Investing

Looking at only the withdrawals from equal levels of retirement savings, however, ignores when the two investors started investing. Retirement savers do not just happen to arrive at their retirement dates with nest eggs that are independent of asset-allocation decisions made over years of saving.

That is where the higher returns of the more aggressive portfolio—because of the historically higher returns of stocks over bonds—added up to a big difference in withdrawals, as shown in Figure 2. This part of the study examined two savers following these same strategies for 30 years, both starting with $10,000 initial savings, $50,000 salaries that increase 3% a year and saving 7% of their annual salaries.

Comparing WithdrawalsThe study found that in rolling, 30-year time periods from the end of 1925 to the end of 2009 (218 periods in all, measured quarterly), there were only four time periods in which the more conservative investor ended up with a larger ending balance than the more aggressive one. Over these rolling 30-year time periods, the higher-equity portfolio accumulated, on average, $163,988 more than the more conservative portfolio.

Taking into account the difference in potential balances at retirement between these two investment approaches, the study took a second look at how investors who planned to withdraw their nest eggs over two years starting in 2008 fared. This time, the study assumed these investors started saving 30 years before retiring at the end of 2007. As shown in Table 1, in this case, the more aggressive investor arrived at retirement with approximately $135,000 more than the conservative investor.

Although the more aggressive investor still lost more money than the relatively conservative investor in the market crash of 2008, his initially greater nest egg at retirement enabled him to withdraw about $35,000 more over the two years—even though he experienced more market volatility in that time. In other words, the more conservative approach to investing—perhaps more attractive to an investor intending to withdraw his nest egg shortly after retirement—did not turn out to be better in this case.

This is a particularly notable outcome given that the decade before the final withdrawal in this study (made in January 2010) was such a poor one for stocks, posing a big handicap for the strategy with higher equity exposure.

The Long-Term Advantage

What if these investors, rather than withdrawing all of their assets over a three-year period, decided to gradually withdraw them over a 30-year retirement period?

We don’t know, of course, what the next 30 years will bring, and past performance cannot predict future results. However, the study also examined how the two strategies performed over all the historical rolling 30-year withdrawal periods from 1925 to 2009.

This analysis assumed that the investors entered retirement with the total assets each had accumulated after 30 years of saving cited in the example above; they continued with their respective investment strategies throughout retirement; and they withdrew about $39,000 (4% of the larger portfolio assets) in the first year, increasing that amount by the Consumer Price Index (CPI) inflation rate each subsequent year.

In this case, the more aggressive strategy was able to provide all the withdrawals and still have money left over after 30 years in 88% of the periods examined. The more conservative strategy was able to provide all the withdrawals in only 12% of the periods. In other words, it ran out of money before 30 years in 88% of the periods.

The portfolio with greater equity exposure is more appropriate for an investor who plans to withdraw his savings gradually throughout retirement, not quickly. Even so, a more aggressive strategy could potentially benefit the investor who expects to take out all or most of his money soon after retiring—even in a down market—if he had pursued the higher-equity approach for a number of years in advance.

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Discussion

Bob from IL posted over 16 years ago:

Nice information for the million dollar portfolio. there are many with much less who retired long ago. Hard to find studies and strategies for the "small people"

Michael from CA posted over 16 years ago:

Bob is right. The "small people," or those of the 98% who did not benefit greatly from the Bush tax cuts, are working as greeters at Costco and Wal-Mart. Or if they can they will work until they drop dead at their desks at age 75.

Jon from AZ posted over 16 years ago:

I don't thing the actual portfolio size is the point. Rather, the point is made also with us not-so-wealthy investors. I suspect we could ratchet down all the figures by a certain percentage and come up with essentially the same results favoring conservative investment styles in the recent past, but more aggressive (higher equity) investing over the long term.

William from KS posted over 16 years ago:

From 1999-2009 bonds outdid stocks' return. The late Peter Bernstein remembered in 1954 bonds outdid stock when he was new as a broker. His colleague assured him, "Don't worry, it's an anomaly." Bernstein wrote in 2008, "I'm still waiting."

Tom from NM posted over 16 years ago:

As above from William, here are some real life results, Dec 2000- June 2010, no new contributions to this tax deferred IRA during this time, listed below is the performance as I calculated them last month. Bond fund up 86% Stock mutual funds up 18%(only positive because of a switch in 2008) Gold up ~6000% I had exactly the opposite ratio of bonds, stocks and metals to take advantage of the metals and materials boom.

S from VA posted over 16 years ago:

The Journal has published summaries of studies by T Rowe Price on this subject for a number of years. But there never seems to be a reference to the specific studies or where they might be found for those of us who would like to read the entire study. Where can the underlying research be found?

B Wildfeir from NY posted over 8 years ago:

Assuming that the retirement assets are in a qualified plan, why would anyone withdraw in 3 years???? This would incur huge taxes! And what would they do with all the assets after the withdrawal?

John Greer from MI posted over 8 years ago:

I think the fact that this is a company selling investing advice means they twisted the scenario to a point that makes you think you need them to get the extra 35K. I can't think of a single reason to take money out as a retirement plan in 3 yrs. Makes the idea of planning for a 30 yr retirement seem wildly crazy. Also, this is from 7 yrs ago. Now the last 7 years has been entirely different. Up 107% in last 7 years to Jan 1 2018.

James Joslin from NC posted over 8 years ago:

It is interesting how more effective equities are in the long-term in accumulating wealth. It is particularly insightful that if you had invested more heavily in equities for a number of years before the 2008 downturn you would still be better off after it than being more heavy in fixed income.

cept4Grace from Washington posted over 7 years ago:

I am 81, retired early, and have no worry of meeting my needs. I still remain invested in wholesome companies that strive to provide well for their clients, employees as well as stock holders. My highest income priority remains to honor God with a thanksgiving offering for his provision in my life. He has enabled me to enjoy needs that are less than income.

reality from NY posted over 7 years ago:

@cept4Grace: So God needs U.S. paper money? Seems like something the alleged creator of the universe should be able to get by without.

Neil from PA posted over 7 years ago:

As B Wildfeir said the basic premise of this so called study is stupid. Who, going into retirement would sell everything over 3 years? How does this help any of us? AAII should be embarrassed to publish a piece like this from an investment company. What's UNBIASED about this?

KENDRICK MILLER from N CAROLINA posted over 6 years ago:

100% S&P EQUITY 3 DAYS AFTER THE S&P PERSISTS ABOVE THE 35 DAY MOVING AVERAGE AND SWITCHING TO 100% SHORT TERM TREASURIES 3 DAYS AFTER THE S&P FALLS BELOW THE 35 DAY MOVING AVERAGE WILL BEAT ANY ALLOCATION MODEL.

charlie bird from Washington posted over 6 years ago:

In 1974 I had a1 yr position at Indiana U. they contributed 2K into TIAA/CREF. I split it 50/50 I was 24 years old When I started to draw it out I had about three times as much in stocks as in bonds. In 1975-76 I did a salary or annuity reductions at u of GA. Valic was not nearly as good at investing as TIAA but still it was about 3/1 stocks. Different time periods will give different results. and YMMV.

DEM from Arizona posted over 6 years ago:

The picture painted in this study is far from complete and too simplistic. The more complete studies show that maintaining a 60% stock funds and 30-40% bond funds allocation will do just fine for the long term. That is what we have done and our annual income has gone steadily up and our total assets have gone up (over 22 years in retirement)

Craig from California posted over 6 years ago:

Certain posters above have RUDELY stated how stupid they think it is to withdraw retirement funds assets in three years. Whether the rude posters like the idea or not, some people want to liquidate their retirement accounts so they can buy annuities and guarantee themselves a lifetime income. Whether that is a good strategy or not can be debated, but it is just plain rude to arrogantly put another person down. Perhaps they don't enjoy managing money, or perhaps they are ill. Note to the rude posters: other people may have different situations/talents than yours, and that does not make them stupid. Remember your manners and think about the bigger picture before you get on your high horse.

Steve Peterson from OR posted over 6 years ago:

It seems to me that any allocation with any amount of bonds have a guarantee of losing to inflation on that portion of your portfolio. 90% to 100% equities has always served me well.

Kurt from ID posted over 6 years ago:

The story mentions at one point that an investor would have "lost" 4% following a particular plan. This may seem picky, but the only way you "lose" (or "gain") in investing is when a transaction occurs. Without a transaction your portfolio's asset value may be up or down, but you have lost or gained nothing. My main account is invested largely in quality dividend-paying stocks that regularly pay me the same income. So I don't care if General Mills is trading at $40/sh. or $50/sh. from year-to-year because I'm an investor not a trader. As for what happens at "final liquidation," that's something for my heirs to worry about.

Mike from Kentucky posted over 6 years ago:

I've been retired for over 15 years. was able to retire early. Anyone can do the math on withdrawals. The tough part is establishing a maximum withdrawal per year that you are comfortable with. We established a very simple system many years ago. When you plan to retire determine what annual income you think you'll need from your investments to supplement any formal pension/SSA sources. Using that conservative estimate, retire and live within those maximum numbers. Any investments beyond those needed to provide income should go into mutual funds with good performance records so they become the growth part of your retirement assets. By the way,my career was as the Retirement Plans manager for nearly 25 years. I retired CEO's of Fortune 500 companies, other executives and many who had far less to live on in retirement. Some decided to delay retirement based on my comments because they realized that they didn't have all the bases covered. They then took corrective action to work toward the formula I'd suggested. I'm not saying I'm always right but as far as planning goes, this seemed to make sense to a lot of people. I'm still active when asked and I've not heard any better ideas than my approach. Please understand my system is not perfect but it's impossible to know all the factors that we will encounter--especially after retirement. This is just one solution; I'm sure there are many other approaches.

Pat from IL posted over 6 years ago:

I read a much more interesting and provoking article on the same subject on Seeking Alpha today. This article reads like it was written in the 50s and has been rehashed multiple times every year since.

Jon from Texas posted over 6 years ago:

This article sort of summarizes my long term investing strategy, which is, I'd rather take a 50% hit on a $2 million portfolio than a 10% hit on a $1 million portfolio.

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