Wrong Way Retirement Income

by David D. Holland


There are two phases of investing for your retirement: the “accumulation phase” and the “distribution phase.” The way you save for retirement (during the “accumulation phase”) should be different than the way you draw from those accumulated savings (during the “distribution phase”). If you use the wrong strategy to produce your retirement income, you could be setting yourself up for financial failure.


Dollar-Cost-Averaging is a commonly used “accumulation phase” strategy where the investor regularly sets aside a specific dollar amount. Millions of working Americans do it each paycheck with payroll-deducted contributions to 401(k) accounts. By investing, say a fixed $100 each month, investors buy more stock or mutual fund shares when the stock market is lower than when it is higher. When the price of investments goes up, we buy fewer shares; when the price goes down, we buy more. If this strategy is used over a long period of time, there is an opportunity for more profit when the stock market goes up. It is like automatically buying more of something when it goes on “sale.” Dollar-Cost-Averaging is considered by many to be a prudent investment strategy when saving for retirement. 


“Dollar-Cost-Ravaging” is what can happen if you try to take money out the same way you put it in. By reversing the Dollar-Cost-Averaging process, you could be setting yourself up to have to liquidate more of your investments when stock prices are lower. Let’s say you are drawing $500 a month from a portfolio of stocks and the market falls 20%. You’d have to increase the number shares you liquidate each month to get the same $500. You’d also be selling those extra shares at a bad time. Imagine if there is a sustained or sharp decline in the stock market (like the 47% market slide from 2000 through 2002 or the 2008 nosedive); the impact on your savings could be devastating if you try to use dollar-cost-averaging in reverse; that’s why I call it “Dollar-Cost-Ravaging.”


Market Allure: The stock market produced a spectacular 12.8% average annual return for the thirty-year period of 1980 to 2009 (I’m talking about the S&P 500 index with dividends, but no taxes). Understandably, some investors (and financial advisers) think they can rely on those kind of returns when planning withdrawals for retirement income. Actually, it would work just fine as long as the annual returns were robust and positive. For example, with annual returns of 12.8%, an original investment of $300,000 would provide $446,000 of total withdrawals ($24,000 a year plus 3% inflation) for income over a fifteen year period and there would still be $432,000 of investments left over! While the stock market has produced an average of 12.8% return over time, it has never actually done so year after year. That makes relying on annual returns to support withdrawals during retirement a problem. How and when you earn your investment gains does not matter when you are saving for the future, just as long as there are gains over time. When you are drawing from your investments for retirement income, “how” and “when” you earn your returns become extremely important. Let’s go back to my $300,000 example. Instead of consistent 12.8% annual returns, let’s now assume fluctuating returns of zero in year one, 6% gain in year two, a 12% loss in years three, four, and five, and then a 24% gain annually for years seven through fifteen. Even though the average annual return is still 12.8% for the entire fifteen year period, the original investment would be depleted by the withdrawals by year ten! The portfolio would never be able to recover from those negative results in years three, four, and five, even with incredibly high performance later. It would take nine years, with 42% annual return each year, to make up for the losses and sustain retirement income withdrawals for the entire fifteen year period.


By now, you are probably asking yourself, “If Dollar-Cost-Ravaging is so dangerous, why would anyone do it?” The other day I saw a woman driving a car with a dog in her lap. She also had a cell phone in one hand and a hamburger in the other! Just because it’s dangerous doesn’t mean some people aren’t going to do it!


How to Avoid Dollar-Cost-Ravaging: Don’t withdraw your monthly income from funds invested directly in the stock market or investments that can go down in value. Carve out enough of your retirement assets to produce the income you need and invest those funds in more secure places, such as: certificates of deposit, laddered bonds, an immediate annuity (create your own pension) or a fixed annuity with lifetime income guarantees. Once you have established reliable sources of retirement income, you can then invest the remaining portion of your retirement assets in growth-oriented investments, like mutual funds and stocks, to fight long-term inflation. It is “okay” for these investments to fluctuate in value if you aren’t drawing on them for your monthly income. As with all investment and financial strategies, your personal circumstances and current conditions will determine what is best for you.


David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show at 9AM on AM1380 Ormond Beach, AM1230 New Smyrna Beach and AM1490 Deland. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.